SOLUTION FINANCIAL MANAGEMENT MAY 2011

QUESTION 1

(a) The maximization of shareholders wealth is to consider the returns that investors
expect in exchange for becoming shareholders. The wealth to shareholders is
measured by two factors:

 The regular dividend payments to shareholders and

 Capital gain made on disposal of shares.

The maximization of wealth then becomes the maximization of such returns to the
shareholders.

Shareholders wealth maximization is considered important than maximization due to the

following reasons:

a. The cash flow paid to shareholders.

b. The timing of the cash flow( the present value or the time value of money)
c. Considers risk associated with the cash flow.

(b) An efficient portfolio is one that provides the highest expected return for any
given degree of risk and also provides the lowest risk for any given expected
return.

(c) Role of a Finance Manager in the Public Sector Organization

Private sector financial objectives are comparatively easy to state and measure: the aim is
to maximize shareholder wealth and a measure of achievement is the amount of profit a
company generates. Public sector objectives are more complex. Public sector
organization can be defined as organizations which have a goal other than that of earning
a profit for their owner. Their primary purpose is to provide services to the public which
would not otherwise be available or not provided within the financial means of all the
member of the public.

Public sector organization and their financial objectives can be divided into three types:

a. Those which are run in order to make a profit and which should be financed
entirely from the charges they make for their goods or services. These include
nationalized industries and organizations like Post Office.
b. Organizations which are not run to create a profit (for example the NHIS);
c. Organizations which are service based, meeting their needs mainly from charges
for their services, but which also are subsidized from taxation.

Organizational which run for profit in the public sector are similar to organizations to the
private sector. They usually have to meet government set targets in the form of a

Page 1 of 8
 SOLUTION FINANCIAL MANAGEMENT MAY 2011

percentage return on capital employed, or are required to break even. However unlike
private organizations public ones are obliged to supply their product or to provide service
to all part of the country continuously, which can obviously hamper profitability. In
compensation though, many public sector organizations enjoy a monopoly situation.
The position of public non-profit making organizations and services based organizations
is different. The financial objective of these two classes is to provide „value for money‟,
buy using the money allocated to them efficiently to allow the organization to discharge
its designated purposes well.
Value for money
The public sector aim of achieving „value for money‟ can be defined as the pursuit of the
economy, efficiency and effectiveness.

(a) Economy this is the obtaining of the appropriate quality resources at the least cost.
The measure is a relative one and can be assessed in two ways: are costs more
than expected, or are costs more than the comparable inputs?
(b) Effectiveness this is concerned with ensuring that the output of the organization
achieves its objectives.
(c) Efficiency this links together inputs and outputs, and measures the amount output
per unit. To be efficient the maximum amount of outputs should be achieved from
the resources put in, or only the minimum level of resources should be used to
achieve a given level of output.

Output is the desired result of the organization. However this is often not easy to measure
because of its lack of quantitative nature. Therefore in order to measure a public service,
such as the Korle-Bu Hospital, quality performance indicators are used to give some idea
of what is being achieved. For example, a hospital‟s performance indicators could include
the number of beds occupied, the number of outpatients treated, and the length of waiting
lists for operations. The indicators can then be compared over time, or with set standards,
etc. it has to be remembered though that.

(d) SICA LIMITED

COMMON SIZE STATEMENT

2010 2009
Revenue 100 % 100%
Cost of sales (47) (47)
Gross Profit 53 53
Distribution costs (22) (23)
Administrative expenses (8) (7)
Operating Profit 24 23
Interest Received 1 1
Other Income 0 1
Profit before tax 25 24
Tax (6) (6)
Profit for the year 19 18
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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

Comments
Cost of sales to sales no change.
Improvement in distribution cost in 2010
Improvement in profit for the year.
Administrative expenses worsened.
No change in finance cost.

QUESTION 2

The relevant cash flows are:

(a) Four demerits of payback period method are as follows:

 It is unable to distinguish between projects with the same payback period.
 It ignores the timing of cash flows within the payback period.
 It ignores the time value of money.
 It may lead to excessive investment in short term projects.

(b) Year 0 Purchase of new machines = GHS 15,000

Year 1 – 5 Contribution from the new product

5,000 (3.2 – 1.5 less contribution = GHS 8,500
Foregone 5,000 x (4 x GHS01.5) = GHS 3,000
= GHS 5,500

(c) The NPV is calculated as follows:

Year Cost Working Contribution Net Cash DCF @ PV of net
Capital flow 20% cash
GHS GHS GHS GHS GHS
0 (15,000) (1,000) (16,000) 1.0 (16,000)
1 500 (500) 0.833 (417)
1–5 5,500 5,500 2.991 16,451
5 1,000 1,500 2,500 0.422 1,005
NPV 1,039

The project should be undertaken because it has a positive NPV.

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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

QUESTION 3

(a)
(i) Weak form
The weak form of efficient market hypothesis stipulates that current share prices
already reflect past price and volume of information. It states that “the
information contained in the past sequence of prices of a security is fully reflected
in the current market price of that security. It implies that no one should be able to
out perform the market using something that “everybody” else know.”

Semi strong form

A market is said to be semi-strong form efficient if share prices reflect all historic
publicity available information. All publicity available information is fully
reflected in the shares current market prices. The public information stated not
only past prices but also data reported in a company‟s financial statements,
company‟s announcement, economic factors and others.

Strong form
Markets are said to be strong form efficient if share prices reflect all information
whether it is publicly or privately available. This means that private or insider
information is quickly incorporated by market prices and therefore cannot be used
to reap abnormal trading profits.

(ii) Benefits of listing on the Ghana Stock Exchange

 It opens up new avenues for the company to raise finance.
 It increases the marketability of the marketability shares.
 It raises the profit of the company.
 The company may obtain better credit rating.
 The company can use it shares to fund future take-over activity.
 Companies enjoy tax concessions under tax laws resulting in a lower
corporate tax rate.
 Companies gain national and international reputation with it share value
quoted on the stock market.
 It provides compliance to corporate governance principles.

(b)
(i) Dividend Valuation Model
Ke = Do (1 + g) + g
Po
Where:
Ke = cost of equity
Do = dividend paid
g= growth
Po = market price per share

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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

Dividend per share = GHS2.6 m

10m
= GHS0.26

Ke = 0.26 (1 + 0.1) + 0.1

3.50
= 0.1817 = 18.17%

ii. Using CAPM :

Ke = Rf + B (Rm – Rf)
Where:
Rf (Risk free) = 11%
B (Beta factor) =?
Rm (Average Market Return) = 15%

Therefore Beta = Std. Dev x Correlation Variance

Market Std Dev.

= 20% x 0.8 = 1.6

10%

Ke = 11% + 1.6 (15% - 11%)

= 17.4%

iii. Both measures of cost of equity is rounded at 18% for the purpose of calculating
WACC.

WACC = [Ke x E ] + [ Kd (1- t) x D ]

MV MV

Ke = 18%
Kd = 11% (1- 0.35) = 7.2%
WACC = [ 18% x 2] + [ 7.2 % x 1 ]
3 3
12% + 2.4% = 14.4%

QUESTION 4

(a) Business risk is defined as the uncertainty inherent in projections of future

generating income or earnings before interest and taxes, while financial risk refers
to (i.) the increased variability of earnings available to the firm‟s ordinary
shareholders and (ii.) the increased profitability of financial distress borne by the
firms‟ owners if the financial leverage is employed b y the firm.

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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

(i)
i. To acquire certain desirable assets at a lower cost.
ii. To achieve greater economies of scale.
iii. To take advantage of raw materials or end-product markets.
iv. A potential to grow rapidly than is possible through internal expansion.
v. Desire to diversify product lines or business.
vi. To take advantage of tax loss carry forwards.

(ii)
i. Number of ordinary shares = 1,800,000 x 0.5 = 900.000
ii. EPS = GHS 1,800,000 + GHS 360,000 = GHS 0.313
6,000,000 + 900,000
iii. Equivalent EPS = GHS 0.313 x 0.5 =GHS 0.157
v. Expected market price = 0.157 x 10 times = GHS 1.57
vi. Market Value = GHS 1.57 x 6,900,000 = GHS 10,833,000

QUESTION 5

(a)
i. Hedging – taking a temporary position in the forward market which is exactly and
opposite to a current or anticipated position in the cash market so that the loss (or
gain) on the forward transaction offsets the loss or gain on the cash transaction.
Hedging in the forward market is the elimination or avoidance of foreign
exchange.
ii. Trading – traders tend to buy and sell contracts continuously each day with the
hope of benefiting from small price changes, and profiting by buying low and
selling high.
iii. Speculation – the opposite of hedging is speculation, which is acceptance of
foreign exchange risk. Speculators will generally take large positions and hold
these for a longer period of time than traders.
iv. Arbitrage – purchase or sale in the forward market and simultaneous sale or
purchase (opposite transaction) in another market, in an attempt to make a profit
in the two markets.

(b)
i. Option – an option is a security that gives its holder the right, but not the
obligation, to buy or sell an asset at a set price during a specified time period.
Options are classified as either call or put options. A call is an option to buy a
particular asset, whereas a put is an option to sell it.

ii. Warrant – a warrant is a company issued option to purchase a specific number of

shares of the issuing company‟s ordinary shares at a particular price during a
specified time period.

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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

iii. Rights Issue – in a rights offering the company‟s existing shareholders are given
an option to purchase a fraction of the new shares equal to the fraction they
currently own, thereby maintaining their original ownership percentage.

(c) ?

(d) i. _______ ____________

 Q= √ 2CoD = √2 x 20 x 40,000 = 2,000 units
Ch 0.4

 This means that there will be:

40,000 = 20 orders placed each year.
2,000

 The inventory cycle is therefore:

52 weeks = 2.6 weeks
20 orders

 Total cost will be (20 x GHS 20) + [ 2,000 x 40 p] = GHS 800 a year.
2

ii.
The change in credit policy is justified if the rate of return on the additional
investment in working capital would exceed 30%.
Extra profit
Contribution /sales ratio 15%
Increase in sales revenue GHS 1,200,000
Increase in contribution and profit GHS 180,000

a. Extra investment, if all accounts receivable take two months credit.

GHS
Average accounts receivable after the sales increase
(2/12 x GHS 6,000,000) 1,000,000
Less current average accounts available (1/12 x GHS 4,800,000) 400,000
Increase in accounts receivables 600,000
Increase in inventories 200,000
800,000
Less increase in accounts payable 40,000
Net increase in working capital investment 760,000

Return on extra investment GHS 180,000

GHS 760,000
= 23.7 %

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 SOLUTION FINANCIAL MANAGEMENT MAY 2011

b. Extra investment, if only the new accounts receivables take two months credit
GHS
Increase in accounts receivable (2/12 x GHS 1,200,000 200,000
Increase in inventories 200,000
400,000
Less increase in accounts payable 40,000
Net increase in working capital investment 360,000

Return on extra investment = GHS 180,000 = 50%

GHS 360,000

The policy is worthwhile only if the existing customers stick to the 1 month and
only the new customers take the two months.

Page 8 of 8
THE INSTITUTE OF CHARTERED

ACCOUNTANTS (GHANA)

MAY 2012 EXAMINATIONS

(PROFESSIONAL)

PART 3

FINANCIAL MANAGEMENT

(Paper 3.4)

Attempt ALL Questions

TIME ALLOWED:

Reading & Planning - 15 Minutes

Workings - 3 Hours

Page 1 of 5
QUESTION 1

(a) Say Die Limited is an unlisted company with 1.5 million ordinary shares of GHC1 each currently
valued at GHC2.40. The dividend of GHC432,000, which has been constant for several years, has
just been paid. The company wishes to finance a new project with an amount of GHC1.8 million
of 7% irredeemable debentures.

Shareholders will expect their dividend to rise by GHC36,000 as a result of the increased gearing.

You are required to find:

(i) the original cost of equity (3 marks)

(ii) the new cost of equity (3 marks)

(iii) the true marginal cost of debentures (3 marks)

(iv) the weighted average cost of capital. (4 marks)

(b) (i) You are looking into an investment that will pay you GHC12,000 per year for the next
10 years. If you require a 15% return, what is the amount you would pay into this
investment? (2 marks)

(ii) You have just celebrated your 19th birthday. Your uncle, Efo Sammy has set up a trust
fund for you, which will pay you GHC150,000 when you turn 30 years. If the relevant
discount rate is 9%, how much is this fund worth today? (2 marks)

(iii) You have been offered an investment that will pay you 9% per year. If you invest GHC
15,000, how long will it take to accumulate GHC30,000 and GHS45,000 respectively?
(3 marks)

(Total: 20 marks)

Page 2 of 5
QUESTION 2

A company plans to purchase a new machine due to the expected demand for a new product. The
machine costs GHC185,000 and it is expected that the machine shall be used for five (5) years with a
scrap value of GHC15,000. The company expects the demand for the product to be as follows:

Year 1 2 3 4 5
Demand (Units) 25,000 30,000 35,000 40,000 20,000

The new product will be sold for GHC22 per unit and the variable cost of production is GHC17.80 per
unit. Annual fixed production cost is expected to be GHC15,000. Selling price, fixed expenses and
variable cost are projected to increase as follows:

% Increase
Selling Price 2% per year
Variable Cost of production 3% per year
Fixed production expenses 5% per year

The company’s cost of capital is 10% and pays corporate tax at a rate of 25% in the related year.

Required:Calculate the Net Present Value (NPV) of purchasing the new machine advise whether it
makes economic sense to buy the new machine. (14 marks)

b. Explain the differences among the Transaction Risk, Translation Risk and Economic Risk.
(6 marks)
(Total: 20 marks)

QUESTION 3

(a) Quansa Ltd is reviewing its credit policy. Currently it extends credit terms of 30 days from
invoice date and is considering extending this to 60 days. Currently sales are 10,000 units a
month, priced at GHC12. Direct costs are 90% of sales price. The marketing director believes
that if the credit period is extended sales will increase by 12%. If the current cost of funds to
the company is 11%, should the company extend the credit period.

(i) If the extended credit is only applied to new sales?

(ii) If the extended credit is applied to existing sales as well?

(8 marks)

Page 3 of 5
(b) A small company borrowed GHC10,000 to expand the business. The entire principal of
GHC10,000 will be repaid in 2 years but quarterly interest of GHC330 must be paid every three
months.

Calculate the nominal interest rate that the company will pay. (4 marks)

(c) A strategic customer has approached you, as the Director of Finance of Success Bank Ltd;
for explanation on various money market instruments. Explain the following investments in
the money market.
i. Certificate of Deposit
ii. Commercial Paper
iii. Re-purchase Agreement
iv. Bankers’ Acceptance (8 marks)

(Total: 20 marks)

QUESTION 4

(a) The Ghana Government has issued a 4 year Bond with face value of GHC200 per Bond. The
Bond carries a coupon rate of 12% per annum, with interest payment to be done semi-annually.
If your risk premium is 8% per annum, how much are you willing to pay for the Bond today?
(5 marks)
(b) Your firm has issued GHC 200 million worth of debentures with 15% annual coupon. The debt
is irredeemable.

Issue cost has been 2% of the value of the debenture.In this economy, interest and cost of issue
are tax deductible.

Required:

What is the cost of servicing these debentures if tax rate is 25%?

(4 marks)
(c) Define capital rationing and indicate two (2) each from internal and external factors given rise
to capital rationing.
(5 marks)
(d) Define briefly the following terms:

(i) Interest cover

(ii) Cash flow ratio

(iii) Gearing ratio (3 marks)

(e) Why will a company consider issuing corporate bonds instead ofraising a Bank term loan?
(3 marks)
Page 4 of 5
 (Total 20 marks)
QUESTION 5

(a) Diawuo Comapany is acquiring Ohia Company. Diawuo will issue one of its shares for every
two shares of Ohia Company. The data for the two companies are given below.

Diawuo Ohia
Profit after tax (GHC’000) 150 30
Number of shares (thousands) 25 8
Earnings per share (GHC) 6.00 3.75
Market price of share (GHC) 78.00 33.75
Price-earnings Ratio 13 9

You are required to deal with the following

(i) Calculate the earnings per share of the surviving firm after the merger.
(4 marks)

(ii) If the price-earnings ratio falls to 12 after the merger, what is the premium received by the
shareholders of Ohia (using the surviving firm’s new price)?
(6 marks)

(iii) Is the merger beneficial for Diawuo’s shareholders?

(4 marks)

(b) Briefly describe four (4) defences that could be used by a company after its Board has received
a take-over bid from a predator company.
(6 marks)

(Total: 20 marks)

Page 5 of 5
 MAY 2012 FINANCIAL MANAGEMENT SOLUTION

SOLUTION 1

Say die Limited

(a) Cost Equity

Ke = E = 432___ x 100 = 12%
P 1,500 x 2.4

(b) New Cost of Equity

Ke = 468__ x 100 = 13%
1,500 x 2.4

(c) Marginal Cost of Debentures

Kf = (7/100 x 1,800,000) + 36,000 x 100 = 9%
1,800,000

(d) New Weighted Average cost of Capital

Cost = 360____ x 13% + 1,800___ x 7% = 11%
3,600 + 1,800 1,800 + 3,600

NB Alternatively cost = 2/3 x 12% + 1/3 x 9% = 11%

(a) The amount you would be will to pay is the present value of GHC12,000 per year for 10
years at a 15% discount rate. The cash flows here are in ordinary annuity form, so the
relevant present value factor is
Annuity present value factor = (1- Present value factor)/r
= [1- (1/1.1510)]/0.15
= (1- 0.24.72)/0.15
= 5.0188

The present value of the 10 cash flows is thus

Present value = GHC12,000 x 5.0188
= GHC60,225

(b) We need the present value of GHC150,000 to be paid in 11 years at 9%. The discount
factor is
1/1.0911 = 1/2.5804 = 0.3875
The present value is thus about GHC58,130

(c) The basic equation is

GHC30,000 = GHC15,000 x (1 + 0.09)t
2 = (1 + 0.09)t

NB If we solve „t‟ we get that t = 8.04 years

To get GHC45,000 it will be 12.75 years

Page 1 of 5
 MAY 2012 FINANCIAL MANAGEMENT SOLUTION

SOLUTION 2

1 2 3 4 5
SP 22.44 22.889 23.346 23.814 24.2897
VC 18.34 18.884 19.451 20.034 20.6351
Contribution 4.106 4.005 3.895 3.78 3.6546
Units 25,000 30,000 35,000 40,000 20,000
Total Contribution 102,650 120,150 136,325 151,200 73,092
FC (15,750) (16,538) (17,364) (148,233) (19,144)
Net profit 86,900 103,612 118,961 132,967 53,948
Tax @ 25% 21,725 25,903 29,740 33,242 13,487

Cash Flow

0 1 2 3 4 5
Capital cost (185,000) 15,000
Net Profit 86,900 103,612 118,961 132,967 53,948
Tax (21,725) (25,903) (29,740) (33,242) (13,487)
(185,008) 65,175 77,709 89,221 99,725 55,461
DF 1___ .909__ .826__ .751__ .683___ .620__
(185,000) 59,244.08 64,187.63 67,004.97 68,112.18 34,385.82

NPV = 292,934.68 – 185,000 = 107,935

Go ahead with project.

Transaction risk
This is the risk arising on short term foreign currency denominated transactions which the actual
income or cost may be different from the income or cost expected when the transaction was
agreed.

Translation risk
It refers to the risk involved in consolidating financial statements of a subsidiary which operation
is denominated in a currency different from the currency the parent‟s transactions are
denominated.

Economic risks
It is the risk of the present value of a company‟s expected future cash flows being affected by
exchange rate movements over time.

Page 2 of 5
 MAY 2012 FINANCIAL MANAGEMENT SOLUTION

SOLUTION 3
(a)
(i) Increased Sales 1200 units per month
Extra sales GHC14,400
Extra direct costs 12,960
1,440

Interest cost of extra credit GHC12,960 x 11% x 1/2

It should extend the credit period

(ii) Sales (11,200 units) GHC134,400

Direct costs 120,960
Contribution 13,440
Interest cost on extra credit
GHC120,960 x 11% x 1/2 = 11,088

(b) Since GHC330 is interest only for one interest period

then i = 330__ = 3.3% per quarter
10,000
r = 3.3 x 4 = 13.2% nominal …..

(c) (i) Certificate of Deposit

A certificate of deposit (CD) is a time deposit with a bank. They are generally
issued by a Commercial Bank but can be bought through brokerage. CDs bear
specific maturity date, a specified interest rate and can be issued in any
denomination CDs offer a slightly higher yield than T bills because of the slightly
higher default risk for a bank but overall the possibility that a large bank will go
broke is pretty slim.

(ii) Commercial Paper

Commercial paper (CP) is an unsecured short term loan issued by a corporate
entity typically for financing account receivables and inventories. It is usually
issued at discount reflecting current market interest rate. Maturities on CPs are
usually between one or two months. Typically only companies with high credit
rating and credit worthiness issue commercial paper.

(iii) Re-Purchase Agreement

Re-Purchase Agreements are simply called “repos”. They arise when one party
sells a security to another party with an agreement to buy it back by those who
deal in government securities (T. bills) as a form of overnight borrowing.

For example, a holder of government securities such T. Bills sells the securities to
a lender and agrees to repurchase them at an agreed future date at an agreed price.
The short term maturity nature and government backing provide low risks for
“repos” lenders.

Page 3 of 5
 MAY 2012 FINANCIAL MANAGEMENT SOLUTION

(iv) Banker‟s Acceptance

A Bankers Acceptance (BA) is a short term credit investment created by a non-
financial firm and guaranteed by a bank to make payment. Acceptances are
traded at discount from face value – the secondary market.

For example, with companies, a bank acceptance acts as a negotiable time draft
for financing imports, exports and transaction in goods.

SOLUTION 4

(a) Po = 1 – 1/(1 + v)v x I + R

v (1 + v)v

Vo = ?
v = 8% + 12% = 20% = 10% semi- annual
ϟ = 8
R = 200

Po = 1 - 1/(1.10)8 x GHC12 + 200

10 (1.10)8

(b) Kd = Int (1 – t) or Int (1 – t)

Mv - [ Mvf (1 – t)] Net proceeds

Interest = 15% + 200 = GHC30

Mv = 200
f = .02
Mvf = 0.2 x 2000 = 4
t = .25

Kd = 30 (1 - .25) = 22.5 x 100

200 - 4 (1 - .25) 197 = 11.427

(c) Capital rationing: This is a situation where a company has profitable projects but capital
for investment is limited.

Internal factors
(1) Board of Directors restrictions

(2) Company reluctance to raise equity to avoid dilution.

External factor
(1) Deprived economy

Page 4 of 5
 MAY 2012 FINANCIAL MANAGEMENT SOLUTION

(2) Financiers not will to lend funds due to inability to meet borrowing requirement.

(d) (i)
Interest cover = number of times interest can be covered. i.e.
Profit before Interest
Interest
SOLUTION 5

(a)
(i) - Combined profit after tax = 150,000 + 30,000 = GHC180,000
- Combined shares = 25,000 + 0.54 (8,000) = 29,000
- EPS = 180,000/29,000 = GHC6.21

(ii) - Market price after merger = P/E x EPS

= 12 x 6.21 = GHC74.52
- Premium = [0.5 (74.52) - 33.75]/33.75 = (37.2 – 33.75)/33.75 = 0.104 or 10%

(iii) - The merger is not beneficial to Diawuo shareholders because their price falls
from GHC78 to GHC74.52 – a loss of 4.5%.

(b) Possible post-bid defences that you could have includes

- Formulation of a defence document to shareholders to praise the performance of
the company.
- announcing forecasts of increased profits
- announcing an increase in dividends
- looking for a „White Knight‟
- getting rid of the „Crown Jewels‟
- revaluation of assets

Page 5 of 5
QUESTION 1

(a) Outline the financial benefits and disadvantages inherent in a demerger and indicate
circumstances where it might be an appropriate course of action. (10 marks)

(b) East Ltd has been approached by a foreign government which is privatising its country‟s
railway system. This country is politically unstable. It would like East Ltd to sign up for a
four year joint venture which would require an initial investment by East Ltd of approximately
GHC200 million. It is possible that the contract could be renegotiated at the end of the four
year period. This is the first time that East Ltd‟s management has been asked to consider an
investment overseas.

Required:

Explain to East Ltd‟s management:

(i) The strategies that East Ltd could employ to limit the effects of political risk within this
proposal. (7 marks)

(ii) How a Net Present Value (NPV) appraisal for this overseas investment might prove
problematic for East Ltd compared to a normal Ghanaian-based appraisal. (3 marks)

(Total: 20 marks)

QUESTION 2

(a) Landy Ltd needs to invest in a motor van in order to distribute its products and have to choose
between buying or leasing it. The motor van can be leased for a four year period at
GHC40,000 per annum. The maintenance and service costs are included in the price.
Alternatively, Landy can buy the motor van for GHC120,000 and at the end of four years, its
residual value will be GHC20,000. The maintenance and service costs are estimated to be
GHC13,000 each year. The company‟s cost of borrowing is 12%.

As a financial controller, you are required to advise Landy Ltd whether the company should
lease or buy the motor van. (Ignore taxation) (10 marks)

(b) Tinkler‟s Enterprise operates a large departmental store in the Western Region of Ghana,
which was founded many years ago. Key figures from its financial statements for the year
ended 31 May 2012 are shown below:
GHCm
Revenue 10.00
Gross profit 3.00
Net profit 0.50
Land and buildings (book value) 10.00
Land and buildings (market value) 20.00
Long-term loans 5.00
Bank overdraft 1.00
Shareholders‟ funds 4.00

ICAGP2.40513 Page 1 of 5
 The Tinkler family holds 40% of the ordinary voting shares of the company. The
shareholdings of the family have become widely dispersed around family trusts and individual
family members. The last family members to be a part of the management of the business
retired two years ago. The family is considering the following strategies put forward by the
board for their consideration.

(1) Borrow GHC1 million to develop key departments, with an estimated contribution of
GHC200,000 per year before interest.
(2) Sell the business in six months‟ time to a large rival in exchange for shares with a
current market value of GHC10 million.
(3) Sell the business in management buy out for GHC10 million, one half payable
immediately and the other half in one year‟s time.
(4) Close down the business immediately, this would incur estimated closure costs of
GHC5 million.

Required:

Prepare a report advising the Tinkler family as to the merits and risks involved with the four financial
strategies outlined above. (10 marks)

(Total: 20 marks)

QUESTION 3

(a) Lambert Ltd is an all-equity printing company. It has 40 million ordinary shares in issue and a
market capitalisation of GHC78.4 million (ex-div). Extracts from its financial statements for
the year to 31 August 2012 are shown below:

GHC‟000
Profit before taxation 17,014
Less: Corporate tax at 28% (4,764)
Profit after taxation 12,250

The dividend payout ratio was 100%. Annual earnings and the dividend payout ratio have not
changed over the last few years and are expected to continue at present levels for the
foreseeable future.

Lambert‟s senior management is considering altering the capital structure of the business and
thereby “taking advantage of the tax shield”. It plans to achieve this by buying back 20% of
the company‟s equity shares and paying for this by issuing 9% irredeemable debentures at par.
The share would be purchased for 10 pesewas per share above the current share price.

Accordingly, you, a member of Lambert‟s finance team, have been asked to demonstrate the
impact of such a plan on the value of the company and its cost of capital.

You should assume a corporate tax rate of 28%.

ICAGP2.40513 Page 2 of 5
 Required:

(i) Calculate Lambert‟s current cost of equity capital. (2 marks)

(ii) On the assumption that Lambert‟s current price-earnings ratio remains the same, advise
Lambert‟s management of the effect of its share buy-back scheme on the company‟s:

(a) Total market capitalisation; (3 marks)

(b) Cost of equity; and (2 marks)

(c) Weighted Average Cost of Capital (3 marks)

(iii) Explain why Lambert‟s price-earnings ratio might fall rather than stay constant as a
result of the change in its financial structure. (3 marks)

(iv) Explain the effect of the tax shield on a company‟s market capitalisation. (2 marks)

(b) Pittway Company‟s next annual dividend is expected to be GHC4. The growth rate in
dividends over the following three years is forecast at 15%. After that, Pittway‟s growth rate is
expected to equal the industry average of 5%. If the required rate of return is 18%, what is the
current value of the stock? (5 marks)

(Total: 20 marks)

QUESTION 4

(a) Your brother is planning to retire in 18 years time. He currently has GHC250,000, and he
would like to have GHC1,000,000 when he retires.

You are required to compute the annual rate of interest he would have to earn on his
GHC250,000 in order to reach his goal, assuming he saves no more money.
(6 marks)

(b) The prize in last week‟s lottery was estimated to be worth GHC35 million. If you were lucky
enough to win, then it will pay you GHC1.75 million per year over the next 20 years. Assume
that the first instalment is received immediately.

Required:

(i) If interest rate is 8%, what is the present value of the prize? (5 marks)

(ii) If interest rate is 8%, what is the future value after 20 years? (5 marks)

(iii) How would your answers change if the payments were received at the end of each year?
(4 marks)

(Total: 20 marks)

ICAGP2.40513 Page 3 of 5
QUESTION 5

(a) Zimbo Ltd is a listed, all-equity financed company which manufactures parts for digital
cameras. It is a relatively small operator in a rapidly changing market with high fixed costs.
The company pays out all available profits as dividends.

Zimbo Ltd‟s stated capital consists of 150 million shares issued at GHC1 per share. On 30
September 2012 it expects to pay an annual dividend of 20p per share. In the absence of any
further investment the company expects the next three annual dividend payments also to be
20p, but thereafter a 2% per annum growth rate is expected in perpetuity. The company‟s cost
of equity is currently 15% per annum.

The Marketing Director is proposing a new investment in plant and equipment to manufacture
equipment for digital televisions. This would require an initial outlay of GHC50 million on 30
September 2012. If this investment were financed by a 1 for 3 rights issue, it would enable the
annual dividend per share to be increased to 21p on 30 September 2013 and all further
dividends would be increased by 4% per annum. The new investment is, however, more risky
than the average of existing investments, as a result of which the company‟s overall cost of
equity would increase to 16% per annum if the company were to remain all-equity financed.

The Finance Director argues, however, to the contrary. „It is nonsense to continue to be all-
equity financed. I believe that we could finance the new investment by an issue on 30
September 2012 of 8% irredeemable debentures. Debt would be far cheaper than equity and
the interest is available for tax relief‟.

The Company Accountant has reservations. „New debt finance would add financial risk on top
of the existing high operating risk, which is a particular concern due to the uncertainty of future
sales. I believe that we should continue to use equity finance, particularly with the additional
risk of this new investment; a rights issue is the best way of doing this‟.

The Managing Director is not sure of what to do.

Assume a corporation tax rate of 28%.

Required:

(1) Assuming that Zimbo Ltd remains all-equity financed, and using the dividend valuation model,
calculate the expected ex-dividend price per share at 30 September 2012 on each of the
following bases:

(i) The new investment does not take place

(ii) The new investment takes place

Based on the above computations, determine whether the new investment should be
undertaken. (8 marks)

(2) As an external consultant to the company, advise the company on the implications of the new
investment and the most appropriate method of financing.

ICAGP2.40513 Page 4 of 5
 Your advice should include an analysis of the concerns expressed by the Directors and the
Company Accountant. (5 marks)

(b) The Board of Directors of Crown Oil Ghana Limited have taken a decision to source a foreign
loan facility to expand its business activities at the oil rig enclave. However, the Board is
indifferent about the factors that affect their decision to hedge its market rate exposure.

You are required to:

Identify four (4) main factors that must influence the company‟s decision to hedge its interest rate
risk. (4 marks)

(c) Brown Limited has invested in bond security with the following data available on the bond:

Face value GHC1,000

Coupon rate 16%
Redemption value GHC1,000
Years to maturing 6
Yield to maturity 17%

Required:

How much must you pay for the bond security? (3 marks)

(Total: 20 marks)

ICAGP2.40513 Page 5 of 5
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

SOLUTION 1

a) A demerger results in the splitting up of a firm into smaller, legally separate firms.
The financial benefits and disadvantages are largely dependent upon the individual
situation. Among them are:
Advantages:
1. It is a corporate restructuring strategy that can help a company to raise equity.
2. It helps management to focus on the core operations of the company.
3. Shareholders would get better information about the business unit because it
issues separate financial statements.
4. It helps to reduce internal competition for corporate funds.

Disadvantages:
1. There is difficulty in accessing credit as the de-merged firm may be smaller.
2. The synergy of being a larger firm may be lost.

Reasons for De-merger

1. Where a company has grown too large for its management structure.
2. Selling an unprofitable part or unit to ensure survival of the whole business.
3. Where one part of the company has either a higher or lower level of risk than the
other parts.

b) i. Political risk is defined as the probability of a multinational company being

significantly affected by political events in a host country or a change in the
political relationship between a host country and one or more other countries.

Policies to manage Political Risk

1. Insurance against political risk

2. Negotiation of Agreement
Here, political risk can be addressed by the negotiation of concession agreements
with host governments setting out the rules and restrictions under which the
investing company can expect to conduct its business.
3. Financing and Operating Policies:
Reduce the exposure of political risk by operating policies such as:
- Locating different stages of construction in different countries
- Controlling the means by which finished gods are exported
- Marketing and treasury management outside the host country.
Reduce the exposure of political risk by choosing appropriate financing policies
such as:
- Secure unconditional guarantees from the host government
Page 1 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

(i) Negotiations with local government – obtain a concession agreement. Transfer

of capital, remittances, local finance and government intervention.
- Insurance – make use of the insurance to protect against nationalization,
currency risk
- Management structure – decide on the most effective structure for the business,
such as a joint venture.
(ii) Choice of exchange rate – for future cash flows
- What are the local tax rates? Is there a double tax agreement?
- What discount rate should be used? Would the level of risk affect it?

SOLUTION 2

(a) The cost of leasing the van can be calculated as follows:

Year Cash Flow D/F 12% P.V.
1 (40,000) 0.8979 (35,916)
2 (40,000) 0.7972 (31,888)
3 (40,000) 0.7118 (28,472)
4 (40,000) 0.6355 (25,420)
NPV (121,696)

The cost of buying the van can be calculated as

Purchase Service
Year Costs_ DCF PV Costs_ PV
0 (120,000) 1.0000 (120,000) - (120,000)
1 0.8979 (13,000) (11,372.70)
2 0.7972 (13,000) (10,363.60)
3 0.7118 (13,000) (9,253.40)
4 0.6355 (13,000) (8,261.50)
(39,551.26)
Scrap 0.6355 20,000 12,710
NPV (146,841.26)
Advice: Landy Ltd should lease the van

Page 2 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

(b) REPORT
To: The Tinkler Family
From: An Accountant
Date: Today
Subject: Financial Strategies Under consideration

I have outlined the merits and risks involved with the financial strategies that you are
considering.

Option 1: GHC1 million borrowing to finance the development of key

departments
This option could be said to represent (further) organic growth by the company, that is
to say the funding of internally-generated projects.

The merits of this strategy would be that:

 The company and the family keep control of the business
 The costs of the project are spread over time
 The rate of change with the business is likely to be slower than under other
options.

The main risks would be:

 The risk that the project does not succeed (the ‘strategy’ seems to be a
defensive one – what the company can afford rather than a clear strategy to
differentiate the business)
 The process may be too slow and tentative for the company to survive
 The lenders are likely to want a relatively high rate of interest, given the
company’s current gearing level, bank overdraft and net current assets at zero –
although the land and buildings would seem to provide god security.

Option 2: Sell to a Rival

This option may be said to represent the disposal (or possible acquisition) option.

The main merit of this option would be that the risks of investing in the business would be
removed.

Similarly, the concentration of risk in one entity could be replaced by investment in a more
balanced portfolio.

The main risk would be that the price being offered could be deemed to be too low. (The land
and buildings are said to be worth GHC20 million and the net assets are worth GHC14
million (GHC20m – [GHC5m + GHC1m])

It could be deemed a risk of the offer that it is an offer of shares in the rival rather than ‘cash’.

This offer has the advantage of a degree of certainty (despite the possible change in share
value). The rival is well established; this should reduce risk.

Page 3 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

The shareholders might incur capital gains tax upon disposal of the shares.

The timing of payment (in six months’ time) is likely to be at least as good as the other offers.

Option 3: Management Buy-out

The main merit of this financial strategy is that it is a cheaper alternative to a close down.

Management should be familiar with the business, paying a reasonable price and having a
good chance of success.

The main risks are likely to be that

 There is no guarantee of success
 It is often difficult for MBO teams to immediately finance for a full buy-out
 Management may be concentrating on the buy-out rather than increasing current
profits for the business
 Successful MBOs can lead to big gains for management – on which the previous
shareholders will have lost out.

In this particular case, the Tinkler family would be at risk to the extent of GHC5 million until
the second installment of the consideration were paid and have no control over the operations
of the business during this period.

Again, the price of GHC10 million may be deemed to be too low – the net assets are worth
GHC14 million.

Option 4: Closing the Business

Closing the business represents the liquidation option. The main merit of this approach is that
it allows the assets of the business to be converted into cash before there are (financial) losses
and value is lost to shareholders.

The main risks are that the assets fail to realize the expected values and/or costs are greater
than expected. It appears that liquidation might not be attractive an option for Tinkler.

GHC
Land and buildings at market value 20
Less Closure costs (5)
Net 15
Less Bank overdraft and long-term loans (6)
Realizable 9

This compares with GHC10 million offered by the rival and by the MBO.

Page 4 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

SOLUTION 3

(a) (i) Lambert’s cost of capital:

Dividend/market capitalization = GHC12.25m = 15.625%
GHC78.40m

OR
r = Do x 100 = GHC12.25m = 0.30625
Po 40m

‘r0 = GHC78.40m = 1.96

40m

r = 0.30625 = 15.625%
1.96

(ii) Current P/E ratio = market capitalisation/Earnings = GHC78.40m = 6.4

GHC12.25m

Income statement (after buy-back)

GHC000 GHC000
Profit before interest and taxation 17,014
Less: Debenture interest (9% x GHC16.48m [W1]) (1,483)
Profit before taxation 15,531
Less: taxation (28%) (4,349)
Profit after taxation 11,182

Market capitalisation of equity (6.4 x GHC11.182m) 71,565

Market value of debentures 16,480
Total market capitalisation 88,045

New Cost of equity

D0 = GHC11.182m = 0.34944
32m
P0 = 1.96

Therefore new r = 0.34944 x 100 = 17.828%

1.96

Weighted average cost of capital

WACC = {17.828% x 71.565} + {9% (1 – 0.28) x 16.480} = 15.7%
71.565 + 16.48 71.565 + 16.48

Page 5 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

WORKING 1
Buy-out of shares
20% x equity shares = 40m x 20% 8m shares
Current share price (GHC78.4m/40m) GHC1.96
Buy back price (GHC1.96 + GHC0.10) GHC20.6
Funds required for buy-back (8m x GHC2.06) GHC16.48m

(iii) The price-earnings ratio may fall because the equity holders require a higher rate of
return (ke) because of the company’s increased financial risk, caused by introducing
debt into Lambert’s capital structure. However at lower levels of gearing this may not
be the case and equity holders would not demand an increased return on their
investment.
(iv) Debenture/loan interest is an allowable expense in a tax computation and as a result a
geared company would pay less tax than an equivalent ungeared company. So the
former will have more cash to pay out to investors and will be worth more.
Value of debt + equity = Value of equity in + Tax shield
in a geared firm equivalent ungeared firm

WACC falls as gearing level rises and so the value of the company rises. Eventually,
at higher levels of gearing, WACC will rise again and the value of the company will
fall.

Pittway Company
(b) Current value of stock

Div DF@ 18% PV x Div

1 4 0.8474 3.3896
2 4.6 0.7181 3.30326
3 5.29 0.6086 3.219494
4 6.0835 0.51578 3.13774
13.050094

P4 = 6.0835 (1.05) = 49.13596

0.18 – 0.05

PV price = 0.51578 + 49.13596 = 25.343

Hence P0 = 13.050094 + 25.343 = $38.39

Page 6 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

SOLUTION 4

(a) Future Value (FV) = 1,000,000

Present Value (PV) = 250,000
Time Period (N) = 18 years

FV = PV (1 + i)n
= 1,000,000 = 250,000(1 + i)18
= (1 + i)18 = 1,000,000/250,000
= (1 + i)18 = 4
= 1 + I = (4) 1/18
= I = 1.08 - 1 = 0.08 or 8%

The required rate of interest to reach the goal is 8%.

(b) Payment (MPT) = GHC1.75 million

Number of periods (n) = 20 years,
i. Present value of annuity (PVA) = ? interest rate (i) = 8%

1_ 1 ___
1 - (1 + i)n 1 – (1 + 0.08)20
PVA = PMT x i (1 + i) = GHC1.75 0.08 (1 + 0.08)
= GHC1.75 x 9.8181 x 1.08
= GHC18.56 million

ii. Future Value of Annuity (FVA) = ?, Interest rate (i) = 8%

(1 + i)n - 1
FVA = PMT i (1 + i)

(1 + 0.08)20 - 1
= GHC1.75 0.08 (1 + 0.08)

= GHC1.75 x 45.7620 x 1.08

= GHC86.486 million

Page 7 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

iii. PVA and FVA assuming payments received at the end of year,
Present value annuity (PVA) =? Interest rate (i) = 8%

We have,
1__
1 - (1 + i)n
PVA = PMT x i

1___
1 - (1 + 0.08)20
= GHC1.75 x 0.08

= GHC1.75 x 9.8181
= GHC17.18 million

FV – one year payment

(1 + 0.08)20
= GHC1.75 x 0.08 -1

= GHC80.08 million

SOLUTION 5

(i) The price if new investment does not take place

Div DF@ 15% PV x Div

1 0.20 0.8695 0.1739
2 0.20 0.7561 0.15122
3 0.20 0.6575 0.1315
0.45662

P3 = 0.20 (1.02) = 1.5692

0.15 – 0.02

PV price = 0.6575 x 1.5692 = 1.03174

P0 = 0.45662 + 1.03174 = 1.488369

Value of equity excluding project = GHC1.4884 x 150 million shares = GHC223, 260,000

Page 8 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

(ii) If the new investment take place

0.21__
Share price = 0.16-0.04 = 1.75 i.e. GHC1.75

Value of equity including project = GHC1.75 x 200 million = GHC350,000,000

GHC
Difference in values (350M - 223.26M) 126,740,000
Initial outlay (50,000,000)
Value generated by investment 76,740,000

Thus the new investment appears to be viable.

(a) REPORT

To: The Directors, Zimbo plc

From: A Jones, External Consultant
Date: Today
Subject: Investment and financing of digital television investment

The new investment is significant in relation to the existing size of the company and is
a departure into a related, but new, market. The implications for returns, risk, liquidity
and form of finance thus need to be carefully considered.

The new investment

Returns
The calculations provided in appendix 1 (part (a)) show that, using the divided model,
there is an increase in share price and hence the project appears to be worthwhile. One
minor concern is that, in effect, profits net of taxes are distributed and thus the
increase in annual dividend is an increase in profit rather than cash flows. The
information relating to cash flows of the project has not been provided. Nevertheless,
in the longer term profits are equivalent to cash and the dividend stream is maintained
in perpetuity. Therefore the two can, in this instance, be seen as more or less
equivalent.

Additionally, there appears to be a significant increase in the value of the company, so

there is consideration margin for error.

Risk (Company Accountant and Managing Director)

The existing business relating to digital cameras appear to be risky in the sense of
sales volatility and in terms of cost structure (operating gearing). Nevertheless, the
question of introducing some financial gearing should not be ruled out entirely on risk
grounds without considering other issues. The problem of gearing is examined below.

Page 9 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

Debt financing (Finance Director)

The company currently has zero gearing. The introduction of debt to finance the
project will produce an advantage with respect to the value of the tax shield on
interest.

The finance director is not, however, correct in stating that debt finance at 8% is
necessary cheaper than equity at 15%. The risk of the project is greater than the
average of existing projects, but if the project were debt financed there would be
further financial risk exposure for shareholders in addition to the operating risk. In a
perfect world the cost of equity would rise sufficiently to maintain the weighted
average cost of capital at 15%, but with the tax advantage of debt it would be a little
lower than this.

This point relates to the irrelevance of gearing. This concerns a perfect world (eg no
tax, equal borrowing and lending rates, risk averse investors, costless transactions,
zero bankruptcy costs). The tax shield generates an advantage to gearing but
ultimately bankruptcy costs will create additional cost to gearing as debt approaches
high levels. Moreover, gearing will increase both company specific and systematic
risk and, in the latter case, will demand a price in the market.

A further cost of debt may be the existence of restrictive covenants, which may
prevent the company from taking certain actions, such as the issuing of further debt
ranking above this issue. The importance of financial flexibility would thus need to be
considered.

A final point relates to the form of debt. The finance director argues for a publicly-
issued debenture, but consideration should also be given to privately-issued debt, eg
from a bank. This type of debt tends to have lower interest rates and issue costs than
debenture, but more covenants and other forms of controls.

Rights issue (Company Accountant)

Where a company faces high operating and business risk it may be prudent to limit
financial gearing. The question of the optimal level of gearing is, however, a question
of balancing costs and benefits and, even where other types of risk are high, this does
not entirely exclude the possibility of debt. The debt financing of this new investment
would give a gearing level which would not be high but would still need to be
considered after a more detailed examination and quantification of operating and
business risk.

Regarding the right issue, its main function is to implement pre-emption rights in
respect of existing shareholders, such that they capture the value of the new project
and have the opportunity to maintain their share of equity and control in the company.

The issue costs, while smaller than a public issue of shares, and possibly debentures,
are likely to be greater with a rights issue than with privately-issued debt.

Page 10 of 11
 SOLUTION FINANCIAL MANAGEMENT MAY 2013

Conclusion
The project looks to be viable with a considerable margin of safety, notwithstanding
the fact that it is likely to result in an increased risk to all finance providers. The
optimal form of financing is, however, far from clear: it should be the subject of
further detailed analysis and negotiation with the potential finance providers.

(b) Interest rate risk is concerned with the sensitivity of profit and operating cash flows to
changes in interest rates. A company will need to analyze how its profits and cash
flows are likely to change in response to forecast changes in interest rate and takes
decision as to whether action is necessary.

Factors which could influence the decision to hedge interest rate risk include:
- Future financing plan
- Volatility of interest rate
- Effect of changes in interest on profits
- Effects of changes in interest rate on cash flow

(c) Coupon rate (interest) = 16% @ GHC1,000 = GHC160

GHC
PV of interest GHC160 @ 3.589 = 574.24
PV of redemption value GHC1,000 = 390.00
0.390 _____
Market value 964.24
Or

Market value = 1 - 1_
(1 + r)n x Interest + FV_
r (1 + r)n

1 - 1_ 1000
(1.17)6 x 160 + (1.17)6

= GHC 964.109

Page 11 of 11
QUESTION 1

(a) An investor anticipates Newco’s Security will reach GH¢30 by the end of one year. Newco’s beta is
1.3. Assume the return on the market is expected to be 16% and risk-free rate is 4%. Calculate the
expected return of Newco’s share in one year and determine whether the share is undervalued, overvalued
or properly valued with a current value of GH¢25.

(10 marks)

(b) Big Brother has a debt-equity ratio of 0.75:1. The cost of debt is 8% and the unlevered cost of capital
is 13%. You are required to compute the cost of equity if the tax rate is 25%. (4 marks)

(c) The Winter Wear Company has expected profit before interest and taxes (PBIT) of GH¢2,100, an
unlevered cost of capital of 14% and a tax rate of 25%. The company also has debt that carries a 7%
coupon. The YTM is also 7%. You are required to compute the value of this company

(6 marks)

(Total: 20 marks)

QUESTION 2

(a) Raph Ltd has a 12% opportunity cost of funds and currently sells on terms of net 10 EOM (end-of-
month). The firm has sales of GH¢10,000,000 a year, which are 80% on credit and spread evenly over the
year.

Currently, the average collection period is sixty (60) days. If Chick offered terms of 2/10, net 30, 60% of
its customers would take the discount, and the collection period would be reduced to forty (40) days.

Should Chick change its terms from net/10 EOM to 2/10, net 30? (14 marks)

(b) Many firms that find themselves with temporary surplus cash invest these funds in treasury bills.
Since Treasury bills frequently have the lowest yield of any investment security, why are they chosen as
investments?
(3 marks)

(c) Who are the market participants in the foreign exchange market? (3 marks)

(Total: 20 marks)

Page 1 of 4
QUESTION 3

(a) Maxy Ltd is contemplating the acquisition of Bafsco Incorporated. The values of the two companies
as separate entities are ¢30million and ¢10million respectively. Maxy estimates that by combining the
two companies, it will reduce marketing and administration costs by ¢700,000 per year in perpetuity.
Maxy can either pay ¢15million cash for Bafsco Incorporated or offer Bafsco a 50% holding in Maxy.
The opportunity cost of capital is 10%.

(i) What is the gain from merger ? (2 marks)

(ii) What is the cost of the cash offer? (2 marks)

(iii) What is the cost of the stock alternative? (2 marks)

(iv) What is the NPV of the acquisition under the cash offer? (2 marks)

(v) What is its NPV under the stock offer? (2 marks)

(Total: 10 marks)

(b) The Chief Operating Officer of your company has just been briefed by a consultant who claims that
your company’s share is overvalued.

The Consultant made use of the data below:

Year Total Dividends No. of shares Total earnings

GH¢000 000 GH¢000

1 5,680 28,600 18,260

2 6,134 28,600 21,320

3 8,108 35,000 26,710

4 10,007 40,000 28,620

Your company’s current share price is GH¢6.45 and the cost of equity is estimated to be 12.5%

Required:

With relevant calculations, determine whether your company’s share price is overvalued.

(10 marks)

Page 2 of 4
QUESTION 4

(a) The following information is available for 3 different stocks:

State of Economy Probability of Rate of Return if State Occurs

State of Economy Stock A (%) Stock B (%) Stock C (%)
Boom 0.35 20 35 60
Normal 0.40 15 12 5
Bust 0.25 1 -25 -50

(i) If your portfolio invested 40 percent each in A and B, and 20% in C, what is the portfolio expected
return?

(8 marks)

(ii) If the expected Treasury Bill rate is 3.8%, what is the expected risk premium on the portfolio?

(2 marks)

(b) XYZ Ltd is financed by a mixture of equity and debt capital whose market values are in the ratio of
3:2 respectively.

The debt which is considered risk free yields 8% pre-tax. The average return on the market portfolio is
14% and the beta value of the company’s equity is 0.85. Corporate Tax rate is 25%.

Required:

Calculate the appropriate cost of capital to be used for appraising new projects with the same operating
risk characteristics. (10 marks)

(Total: 20 marks)

Page 3 of 4
QUESTION 5

(a) Distinguish between Call Option and Put Option (4 marks)

(b) You have won lottery and the following prizes have been proposed to you;

(i) GH¢60million now

(ii) GH¢12million a year for 10 years

(iii) GH¢10million per annum forever

(iv) GH¢150million at the end of 10 years.

Interest rate is 10% and will remain same.

Required:

Which option will you choose? (8 marks)

(c) Your company has won a GOG Contract to construct affordable housing units. However, there has
been a delay in the release of the advance mobilization funds to begin the project. The Managing Director
is contemplating sourcing bank overdraft to begin the project. As a Finance Manager of the company,
outline to him three (3) advantages and disadvantages associated with Bank Overdraft.

(8 marks)

(Total: 20 marks)

Page 4 of 4
 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 1

(a) E(R) = 4% + 1.3 (16% - 4%) = 20%

- Given the expected return of Newco’s shares using CAPM is 20% and the investor
anticipates a 20% return, the security could be properly valued.

- If the expected return using the CAPM is higher than the investor’s required return, the
security is undervalued and the investor should buy it.

- If the expected return using the CAPM is lower than the investor’s required return, the
security is overvalued and should be sold.

(b) Re = 0.13 + (0.13 – 0.08) x 0.75 x (1- 0.25)

= 0.158125 = 15.81%

(c) [𝐺𝐻¢ 2100 𝑥 (1 − 0.25)] ÷ 0.14 = GH¢11,250

Vu = GH¢11,250 + (0.25 x 2800) = 11950

SOLUTION 2 (a)

Present Terms New Terms

Credit sales 8,000,000 8,000,000

Average collection period 60days 40days
Average receivables 1,333,333 888,889
Reduction in receivables
from present level 444,444
Return on reduction (12%) = 53,333

Cost of discount being taken = 8,000,000 x 60% x 2% = GH¢96,000

(b) A temporary surplus implies a need for funds in the near future. As such, the qualities looked
for is an investment are the following:

1. Easy marketability
2. Low risk of price changes
3. Low risk of default

The firms want a high degree of liquidity and are prepared to forgo the possibility of a high
return in exchange for a relatively high degree of safety. The higher the possibility of return, the
higher the risk of an investment.

Page 1 of 5
 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 3

(a) Maxy Ltd

(i) Gain = 700,000

0.10
= ¢7,000.000

(ii) Cost of cash offer = cash paid – PVBafsco

= ¢15,000,000 - ¢10,000,000
= ¢5,000,000

(iii) Cost of stock offer = xPVAB - PVB

= 0.5 (30m + 10m + 7m) – 10,000,000

= ¢23,500,000 - ¢10,000,000

= ¢13,500,000

(iv) NPV = Gain – cost

= 7,000,000 – 5,000,000
= ¢2,000,000

(v) NPV = Gain – cost

= 7,000,000 – 13,500,000
= -6,500,000

Year Dividend Growth in

Per share dividend
𝑑𝑖
(Pesewas) 𝑔 = (𝑑𝑜 )1/𝑛 − 1

1 19.86 -

2 21.45 8%

3 23.17 8%

4 25.02 8%

Page 2 of 5
 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

With a constant growth in dividend of 8%, using the dividend valuation model, the price of the
company should be:

Price = D = 25.02 (1.08) = GH¢6.00

Ke – g 0.125 – 0.08

Over valuation is 6.45 – 6 = 0.45

SOLUTION 4

(a) (i) Expected Return

Stock A = (0.35 x 0.20) + (0.40 x 0.15) + (0.25 x 0.01)

= 0.07 + 0.06 + 0.0025 = 0.1325

Stock B = (0.35 x 0.35) + (0.40 x 0.21) + (0.25 x -0.25)

= 0.1225 + 0.0480 – 0.0625 = 0.1080

Stock C = (0.35 x 0.60) + (0.40 x 0.05) + (0.25 x -0.50)

= 0.21 + 0.02 – 0.1250 = 0.150

Portfolio Return = (0.40 x 0.1325) + (0.4 x 0.1080) + (0.2 x 0.1050)

= 0.0530 + 0.0432 + 0.0210
= 0.1172

(ii) The expected risk premium for the portfolio

= 0.1172 – 0.0380
= 0.0792

𝐸 𝐷
(iii) WACC = [𝑘𝑒 𝑥 𝐸𝑥𝐷] + [𝑘𝑑 (1 − 𝑡)𝑥 ]
𝐸𝑥𝐷

Ke = Rf + B (Rm – Rf)
8% + 0.85 (14-8) = 13.1%

Kd = 8%
E=3
D=2
3 2
[13.1 𝑥 3+2] + [8% (1 − .25)𝑥 3+2 ]

7.86 + 2.4 = 10.26%

Page 3 of 5
 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 5

(a) Call Option: A right to buy foreign currencies at a strike price at a price premium at a
given time.

Put Option: A right to sell foreign currencies at a strike price at a price premium at a
given time.

(b) (i) pv = GH¢60

(ii) pv 1-1
(1.10)10 x 12 = GH¢73.73
.10

(iii) pv (perpetuity) = GH¢10 = GH¢100

.10

(iv) pv = 1
(1.10)10 x 150 = GH¢57.83

*Choose option (iii)

(c) Advantages of Overdraft facility

(i) A bank overdraft facility is quick and cheap to arrange as the borrower does not
need to undergo the stringent scrutiny subjected to borrowers of long term longs.

(ii) The company only pays interest on a bank overdraft facility only when it has a
debit balance in its bank account.

(iii) An overdraft is flexible as the borrower only borrows what they need to use at the
time and this makes it cheaper than loans.

(iv) There are no penalties or charges for paying off the overdraft earlier as the
borrower can repay the overdraft at any time.

Page 4 of 5
 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

Disadvantages of Overdraft

(i) A bank overdraft is usually a privilege offered to customers for banking with a certain
bank.

(ii) A bank overdraft facility poses a risk to the availability of working capital support to
a business if the bank decides not to renew it.

(iii) Bank overdrafts are repayable on demand and the lender may call them anytime. The
withdrawal of the overdraft facility may put pressure on the cash needs or day to day
financing needs of the business.

(iv) Overdraft are usually secured against business assets and the lender can take control
of the business assets if it defaults in its repayment.

Page 5 of 5
SOLUTION: FINANCIAL MANAGEMENT, MAY 2014
 MAY 2016 PROFESSIONAL EXAMINATION
FINANCIAL MANAGEMENT (2.4)
EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

EXAMINER’S REPORT

STANDARD OF PAPER
The standard of the Financial Management paper appeared very high for that level,
difficult in some instances and loaded with a lot of sub questions (a to d). This is
reflected in the 16 page typewritten scheme. This combined with other factors on
students’ side highlighted below produced one of the lowest pass rates in recent times
in Financial Management. The questions were well spread across the subject areas and
also covered well both quantitative and non-quantitative aspects of the syllabus.
The questions were generally clear and precise in some instances and ambiguous in few
instances that required more thinking especially the quantitative part of the questions.
No typographical errors were noticed and no errors were found in the questions.
The few errors found were mainly in the marking schemes which were corrected at co-
ordination stage before conference marking commenced. No substandard question was
noticed in the paper and all questions were found to be of very high standard to meet
the standards expected at that level and exceed in certain instances
Mark allocations were generally ok and in the few cases where it was observed not to be
fairly allocated, they were slightly modified at the co-ordination level to ensure a
balance in the allocation.

PERFORMANCE OF CANDIDATES
The performance of the students in the paper was generally poor and below average
with 6% passing the paper after marking and moderation, the lowest in recent history.
It was also noticed that performance were generally worst in centres outside Accra
mainly in the 3 Northern Regions, Volta Region and the other centres out of the capital

Analysis of performance

May 2015 % November % May 2016 %

2015
Candidates 153 21.22 42 7.17 39 6.04
passed
Candidates 568 78.78 544 92.83 607 93.96
failed
Total 721 100 586 100 646 100
Candidates

Page 1 of 31
The possible reasons for the poor performance were as follows:
 Difficult paper for that level
 Poor preparations by students as answers provided clearly showed lack of or
inadequate knowledge of the subject area
 Poor tuition services provided especially out of Accra centres
 Failure of students to thoroughly study and use ICA syllabus and content
manuals
 Poor quality and background of students who wrote the paper vis-a-vis the very
high standard of the questions and expected standard at that level
 Poor knowledge by students on exam preparation and questions answering
techniques
 Limited access to study materials especially the out of Accra centres

The poor performance was across all centres and was more pronounced in centres
outside Accra. There was no any evidence of copying in the exams. The level of
preparations as reflected in the content of the answers showed poor or inadequate
preparation by the students to adequately answer the questions that were very high
standard in nature. Basic Finance terms and terminologies were responded to as if
answers were provided by non-finance students with most students trying to write
English or non-finance language generally to answer the finance questions that required
the understanding and use of Finance language for the easy type questions. Answers
provided in some cases were unrelated to the question.

NOTABLE STRENGTHS
The very few students who did well exhibited the following strengths:
 Reading and understanding of the questions
 Well planned responses to the questions in line with the requirements of
questions
 Very legible handwriting making reading and marking easier and better
 Well prepared and showed strengths in both quantitative and written questions
 Avoidance of mixing different answers to different questions and scattering of
answers across difference pages mixed with answers of different questions

NOTABLE WEAKNESS
 Poor understanding of Finance principles
 Poor exam preparation
 Failure to comprehend the requirements of the questions
 Wrong numbering of answers to questions making it difficult for examiners
 Writing on areas not required by the questions

Page 2 of 31
FINANCIAL MANAGEMENT QUESTIONS
QUESTION ONE

ABC Ltd is considering five projects for the coming financial year. Four of the
projects have undergone financial appraisal (see the table below).
Project Lifespan Initial NPV (GH¢) IRR
investment
(GH¢)
PA201 Indefinite (50,000) 85,200 11.5%
PA202 Indefinite (75,000) 98,500 12.3%
PA203 Indefinite (48,000) 65,950 10.2%
PA204 Indefinite (85,000) 95,400 11.4%
PA205 Indefinite (150,000) Yet to be Yet to be
appraised appraised

Project PA205 entails an immediate capital investment of GH¢150,000 and will

produce the following annual net cash flows in real terms:
Year 1 2 3 4 5 Every year
after year 5
Cash flow
(GH¢) 5,000 10,500 25,000 28,000 30,000 30,000

Expected general rate of inflation is 15% and the company’s money required rate
of return is 25%.

Required:
a) Appraise Project PA205 using the NPV criteria. (4 marks)
b) Assess the sensitivity of Project PA205 to the discount rate. (4 marks)

c) Suppose in the coming financial year, only GH¢200,000 of finance will be

available for investments but the capital constraint will ease afterwards. Advise
the company on which project(s) to implement in the coming year if the projects
are –
i) Independent and divisible
ii) Independent and indivisible (6 marks)
d) When management rejects projects with positive net present value because of
capital constraints, they lose opportunities to enhance the value of shareholders.
Suggest three practical ways of dealing with capital rationing so as not to discard
projects with positive net present value. (6 marks)
(Total: 20 marks)

Page 3 of 31
QUESTION TWO

XYZ Ltd is a leading producer of mineral water in Ghana. The company sells all
of its output to wholesalers on credit terms net 40. The company’s collection
policy is somewhat relax, and so the receivables turnover days is currently 53
days. This fairly liberal credit policy has resulted in significant increases in sales
revenue in recent years. However, the company has been facing cash flow
problems as a significant number of customers take longer than the credit period
to settle their accounts. The company typically falls on overdraft facilities from
its bankers when it fails to generate adequate cash flows from operations to meet
working capital requirements. The average cost of the overdraft facilities is 15%
per annum.

Last week, the management team met and discussed the company’s cash flow
and liquidity problems with a view to finding solutions to the problems. In that
meeting, two proposals were offered to help solve the problems:

Proposal 1: Introduce early settlement discount of 1.5% on accounts that are

settled within 10 days in which invoice is sent while the current credit period is
maintained. It is estimated that 60% of accounts will be paid within the discount
period.

Proposal 2: Switch from financing working capital requirements using the bank
overdraft facilities at 15% interest to financing working capital requirements
using supplier’s trade credit. Suppliers are willing to supply on credit terms
1/10, net 40.Proponents of the proposals believe that the implementation of their
proposals will improve on the company’s financial situation.

Set out below are the company’s income statement and statement of financial
position for the past three years.

Income statement for the year ended 31st December

2012 2013 2014

GH¢'000 GH¢'000 GH¢'000
Revenue 40,000 60,000 122,000

Cost of sales (15,000) (31,000) (90,000)

Gross profit 25,000 29,000 32,000
Selling and administrative
expenses (11,000) (13,000) (17,500)
Operating profit 14,000 16,000 14,500
Page 4 of 31
 Statement of financial position as at 31st December
2012 2013 2014
GH¢'000 GH¢'000 GH¢'000
Noncurrent assets:
Property, plant and equipment 13,400 19,000 22,500
Current assets:
Inventory 8,000 15,500 25,500
Trade receivables 6,900 11,210 24,210
Cash 1,110 - -
Total current assets 16,010 26,710 49,710
Total assets 29,410 45,710 72,210
Equity:
Stated capital 100 100 100
Income surplus 18,510 28,110 36,810
Shareholders' equity 18,610 28,210 36,910
Non-current liabilities:
Medium-term loan 3,000 2,500 2,000
Current liabilities:
Trade payables 2,200 3,500 8,600
Dividend payable 5,600 6,400 7,500
Bank overdraft - 5,100 17,200
Total current liabilities 7,800 15,000 33,300
Total laibilities 10,800 17,500 35,300
Total equity and liabilities 29,410 45,710 72,210

Required:
a) Considering the background information and financial data provided above,
would you conclude that XYZ Ltd is experiencing overtrading? Explain with
relevant computations. (9 marks)
b) Appraise the proposal for early settlement discount (i.e. Proposal 1) and
advise on whether it should be accepted for implementation or not. Your
appraisal should focus on how the discount policy will influence the
company’s profitability. Show all relevant computations. (5 marks)
c) Appraise the proposal to switch from financing working capital needs using
bank overdraft to using suppliers’ trade credit, and advise management
accordingly. Show all relevant computations. (3 marks)

Page 5 of 31
 d) Assuming XYZ Ltd cannot raise additional funds from external sources such
as borrowing and new share offer, suggest to management three steps they
can take to ease the cash shortages the company is facing. (3 marks)
(Total: 20 marks)

QUESTION THREE

a) Governments take certain measures with a view to influencing aggregate

demand in their economy.
Required:
i) Distinguish between fiscal policy and monetary policy. (2 marks)
ii) Explain TWO adverse effects a contractionary fiscal policy could have on
businesses. (4 marks)

b) Papa’s Skin Ltd is an Accra-based clothing company owned and managed by its
two founders. The company has been selling to only domestic consumers in
Ghana since inception. The founders think it is time to extend the operations of
the company to foreign markets, particularly those in neighbouring West African
countries. Moving into foreign markets requires additional financing and
capabilities, which the company does not have. The owners have agreed on
ceding 40% stake in their company to a strategic investor who would provide the
additional financing and capabilities needed to compete successfully in the
international business environment. However, they are not sure of what range of
prices to accept for the shares they would give up.
Below is a summary of financial data for Papa’s Skin Ltd for the recent financial
year:

Issued shares 2 million

GH¢’000

After-tax profit 9,600

Total dividends 1,920

Property, plant and equipment 50,500

Current assets 25,300

Long-term borrowings 9,100

Current liabilities 11,100

Page 6 of 31
 The following information are relevant to the position and value of Papa’s Skin
Ltd:

1) The assets of Papa’s Skin Ltd were valued just after the recent financial
statements were published. Inventories and trade receivables, which are
included in current assets, were written down by GH¢80,000 and GH¢95,000
respectively. Property, plant and equipment were valued at GH¢52,400,000.
2) Papa’s Skin Ltd falls into the fabrics and clothing industry. The average P/E ratio
for listed equity stocks in the industry is 10. The average required return on listed
equity stocks in the industry is 16%.
3) Marketability of shares in Papa’s Skin Ltd is limited as its equity stock is not
listed on the stock exchange. Consequently, investors demand a marketability
risk premium of 7% above the industry average required return on equity in
order to invest in the equity stock of Papa’s Skin Ltd.
4) Earnings and dividends of Papa’s Skin Ltd are expected to grow by 5% every
year to perpetuity.

Required:
i) Estimate an appropriate required rate of return on the equity stock of the
Papa’s Skin Ltd. (2 marks)
ii) Estimate a range of suitable considerations for 40% stake in Papa’s Skin
Ltd using the net assets method, P/E ratio method, and dividend
valuation method. (12 marks)

(Total: 20 marks)

QUESTION FOUR

a) The Directors of Moore Plastics Ltd have been deliberating on the company’s
capital structure with a view to identifying an optimal financing mix. Opening
the deliberation, the Board Chair remarked “For the past 10 years, we have
deployed a financing strategy of reinvesting as much profit as available. When
profit is inadequate, we go for borrowing. New equity offers have been a last
resort”.

Required:
i) Explain with THREE reasons why most managers tend to use financing
strategies that follow the pecking order. (6 marks)
ii) Identify and explain TWO factors the directors of Moore Plastics Ltd should
consider in redesigning the company’s capital structure. (4 marks)

Page 7 of 31
b) Pusher Mining Ltd, a large listed company, operates five mineral concessions in
Ghana and Ivory Coast. The company’s financial performance for the past five
years has been impressive. The company’s recently published financial results
indicate that it earned after-tax profit of GH¢250 million and paid dividends of
GH¢50 million out of that profit.
Reserves at two of the five mineral concessions will be exhausted in two years’
time, and stakeholders fear this will adversely affect the company’s profitability.
Nevertheless, the directors are aiming at maintaining the company’s dividend
payment record. To achieve this, they want to pursue a new project in the oil
industry to provide additional cash flows. Though the new project will be
financed with existing equity and long-term debts, the directors are not sure
what cost of capital to use in appraising the new project.

A summary of the company’s financial position before the new oil project
follows;

GH¢m
Noncurrent assets 620
Current assets 425
Total assets 1045
Equity:
Stated capital 180
Income surplus 685
Shareholders' fund 865
Liabilities:
Current liabilities 20
Bank loans 40
Bonds 120
Total liabilities 180
Total equity and liabilities 1045
Notes:
1. Stated capital: Pusher has in issue 40 million ordinary shares of no par value, all
of which are listed on the stock exchange. The current market value of the
ordinary stock is GH¢5.5 per share. It is estimated that the market value of the
ordinary stock will increase by 8% per annum. The equity beta is 1.25.
2. Bank loans: These are fixed rate loans from banks in Ghana. The after-tax cost of
the loans is 14.5%.
3. Bonds: These are 16% coupon bonds with face value of GH¢100 each. The bonds
are currently trading at GH¢98.1 each. In 10 years’ time, the bonds may be either

Page 8 of 31
 converted into 10 ordinary shares or redeemed at face value at the choice of
bondholders. Bondholders are assumed to be rational investors.

If the new oil project is implemented, Pusher Mining Ltd.’s main competitor in
the oil industry would be Cargo Oil Ltd. The estimated equity beta of the
competitor is 1.80 and the market value of its equity stock is GH¢150 million. The
long-term debt stock of the competitor is valued at GH¢100 million. The
systematic risk of debt stocks is assumed to be zero. The risk-free return is 14%
and the market return is 20%. The corporate tax rate is 25%.

Required:
Estimate the appropriate cost of capital Pusher Mining Ltd should use in
appraising the new project in the oil industry. Show all relevant computations.
(10 marks)
(Total: 20 marks)

QUESTION FIVE

a) AD Ventures, imports tomato paste from Italy for sale in Ghana. AD Ventures
typically buys the tomato paste on open account and pays the euro invoice value
two months after receipt of goods. AD Ventures has suffered heavy exchange
rate losses of late due to the continuous depreciation of the Ghanaian cedi
against the euro. AD Ventures will receive a consignment of tomato paste on 15th
May, 2016. The value of this consignment is EUR540,000, which must be settled
in two months’ time (settlement deadline being 15th July, 2016).
The current spot exchange rate for the euro is GH¢4.7110/EUR. Financial
pundits forecast that the Ghanaian cedi will depreciate against the euro in the
coming months. The owner-manager of AD Venture, Akua Donkor, is worried
about probable foreign exchange loss her business may suffer when the invoice
value is settled in two months’ time.

Akua Donkor has heard of the possibility of hedging AD Ventures’ currency

exposure with a forward contract or futures contract but does not know what
these contracts are. She has asked you to advise her on what to do to hedge
against the underlying exposure relating to the EUR540,000 tomato paste
consignment.

You would like to recommend a futures market hedge to Akua Donkor. You
searched the derivatives market; and you found a futures contract on the euro
that matures in August 2016. Other relevant details of the contract follow:

Page 9 of 31
 Contract size EUR100,000

Futures contract price GH¢4.8112/EUR

Required:
i) Explain to Akua Donkor FOUR differences between a forward contract and a
futures contract. (4 marks)
ii) Currency risk exposure may be transaction risk, economic risk, or translation
risk. Which of the three kinds of currency risk exposure is AD Ventures
facing in relation to the EUR540,000 tomato paste consignment. Explain why.
(4 marks)
iii) Explain to Akua Donkor, THREE disadvantages of hedging the euro
exposure with futures hedge. (6 marks)

b) It has been observed that interest rate on debt securities or loans differ for
different maturities. For the week ending 28th August 2015, the annual interest
rate on the 1-year Government of Ghana note was 22.5% whereas the annual
interest rate on the 2-year note was 23%.

Required:
With THREE reasons, explain why interest rates on debt securities and loans are
different for different maturity periods. (6 marks)

(Total: 20 marks)

Page 10 of 31
FINANCIAL MANAGEMENT SCHEME

QUESTION ONE

(a) NPV can be computed by discounting the real cash flows with the company’s real
rate of return. Discounting the project real cash flows with the real rate of return
produces an NPV of GHS152,666:

Discount Factor
End of Year NCF @ 8.7% PV

0 (150,000) 1 (150,000)
1 5,000 0.92 4,600
2 10,500 0.846 8,883
3 25,000 0.779 19,475
4 28,000 0.716 20,048
5 30,000 0.659 19,770
6 and every year
thereafter 30,000 7.575 227,250
NPV = 150,026

Comment: Since the NPV of the project is positive, the value of the firm will increase
when the project is implemented. The project should therefore be accepted for
implementation.

Workings:
1. Discount rate
The real rate of return is estimated using the Fisher’s equation as under:
1 + 𝑖 = (1 + 𝑟)(1 + ℎ)
Nominal rate, i = 25%
Inflation rate, h = 15%
Therefore, the real rate of return is 8.7%
1 + 0.25 = (1 + 𝑟)(1 + 0.15)

1 + 0.25
𝑟= − 1 = 0.087
1 + 0.15

2. Discount factor for equal cash flows occurring every year from year 6 to infinity

Page 11 of 31
 The equal annual cash flow of GHS30,000 from year 6 to infinity is first
discounted as a perpetuity to obtain the terminal value at end of year 5:
1
Terminal value of constant CF from 6 to infinity = GHS30,000 ×
0.087
The terminal value is then discounted as a single amount to obtain the PV at time
zero:
1 1
PV of constant CF from 6 to infinity = ( GHS30,000 × )×
0.087 (1 + 0.087)5
The aggregate discount factor is therefore 7.575:
1 1
Aggregate discount factor = × = 11.494 × 0.659 = 7.575
0.087 (1 + 0.087)5

NB: Some candidates may round the real rate of return to 9% so as to read
discount factors from interest factor tables (if provided). In this case, the NPV
would be GHS138,715. Full credit should be awarded to candidates who
answer the question in this manner.

(b) The sensitivity of the project’s NPV to the discount rate can be estimated as the
percentage change in the discount rate needed to reduce NPV to zero.
IRR − Discount rate
Sensitivity percentage = × 100%
Discount rate

15.8% − 8.7%
Sensitivity percentage = × 100% = 72.4%
8.7%

That is the discount rate will have to increase by 72.4% for the NPV to reduce to
zero. The high percentage increase required in the discount rate for the NPV to drop
to zero implies Project PA205 is less sensitive to variation in the discount rate.

The IRR is calculated by trial and error as under:

NPVL
IRR = iL + [( ) × (iH − iL )]
NPVL − NPVH

Setting iL = 15% and iH = 17%, NPVL and NPVH are computed as under:

End of Year NCF DF (15%) PV @15% DF (17%) PV @17%

0 (150,000) 1.000 (150,000) 1.000 (150,000)
1 5,000 0.870 4,350 0.855 4,275
2 10,500 0.756 7,938 0.731 7,676
Page 12 of 31
3 25,000 0.658 16,450 0.624 15,600
4 28,000 0.572 16,016 0.534 14,952
5 30,000 0.497 14,910 0.456 13,680
6 and every
year
thereafter 30,000 6.667 x 0.497 99,405 5.882 x 0.456 80,466
NPV @ 15% = 9,069 NPV @ 17% = (13,351)

The IRR of the project is 15.8%:

GHS9,069
IRR = 0.15 + [( ) × (0.17 − 0.15)] = 0.158
GHS9,069 + GHS13,351

(c) Project selection under single period capital rationing

i) If projects are independent and divisible
When a firm faces capital rationing for a single period and projects are
independent and divisible, funds may be allocated to projects based on the
profitability index rankings.

PI =
NPV/Investmen
Project Investment NPV t Rank
PA201 50,000 85,200 1.70 1
PA202 75,000 98,500 1.31 3
PA203 48,000 65,950 1.37 2
PA204 85,000 95,400 1.12 4
PA205 150,000 150,026 1.00 5

Fund allocation to projects based on PI rankings and respective NPV follow:

Investment
Project required Fund allocation NPV
PA201 50,000 50,000 85,200
PA203 48,000 48,000 65,950
PA202 75,000 75,000 98,500

PA204 (balance) 85,000 27,000 30,299*

PA205 150,000 - -
200,000 279,949

Page 13 of 31
 That is the company should invest fully in projects PA201, PA203, and PA202;
31.76% in PA204 (27,000/85,000); and nothing in PA205 which is at the bottom of
the ranking. The optimum aggregate NPV is GHS279,949.
Workings:
* NPV from PA204 is its NPV multiplied by the proportion of the investment
requirement the company will allocate funds to (i.e. GHS95,400 x 31.76%).

ii) If projects are independent and indivisible

Here we consider a combination of the projects and select the combination that
will produce the highest combined NPV. Any unused funds may be invested
externally (e.g. in securities).

Combined Unused funds

Investment Combined
Combination of Projects Requirement NPV
PA201, PA202,and PA203 173,000 27,000 249,650
PA201, PA203, and PA204 183,000 17,000 246,550
PA201 and PA205 200,000 0 235,226
PA203 and PA205 198,000 2,000 215,976

The company should invest in projects PA201, PA202 and PA203 to earn the
highest combined NPV of GHS249,650. The unused funds of GHS27,000
should be invested externally.
(d) Practical ways of dealing with capital constraints so as not to lose
opportunities to further increase the value of the company further include
the following:
 Seek joint venture partners with which to share projects investment
requirement
 Use licensing or franchising arrangement with other entities to get the
product produced and sold. The firm will earn royalties while avoiding
financing of the investment requirements.
 Contract out parts of the project to subcontractors who would finance the
project in advance.
 Seek alternative financing such as venture capital and asset securitization.
 Seek grants or aid from government or organizations if the project advances
an object the government or such organizations promote or seek to achieve.

Page 14 of 31
EXAMINER’S COMMENTS
This question was very involving from (a) to (d) with sub questions. Students were first
expected to calculate the discount rate and then using that to discount the future cash
flows including annuity cash flows. Most students could not compute the discount rate
making it difficult for them to calculate the PVs and the NPV correctly and the decision.
The addition of the annuity cash flows further compounded the complexity of the
question to the students.
Additionally the sensitivity analysis aspect of the questions and rankings together with
the capital rationing all in one question made the question loaded and posed a
challenge to students from both understanding and answering the question and also
from time management perspective. The (d) aspect of the question was straight forward
Students fared poorly in answering this question

QUESTION TWO:

(a) Is XYZ overtrading or not?

To conclude whether the company is overtrading or not, candidates are expected to identify
the symptoms of overtrading and diagnose the company’s situation from the information
given to establish whether those symptoms exist or not. Analysis of financial ratios such as
growth in sales revenue, growth in current assets, receivables turnover days, inventory
turnover days, debt ratios, and liquidity ratios is relevant to the diagnosis.

Overtrading occurs when a company tries to do too much too quickly with too little
long-term capital. Typically, a company that is overtrading would exhibit the
following symptoms:
 Rapid growth in sales revenue.
 Rapid growth in current assets, particularly inventory and receivables.
Inventory turnover days and receivables turnover days might grow longer.
 There is only small growth in equity capital, which may be through
reinvestment of profit and not new equity issue. Much of the growth in assets
is financed by credit, particularly, trade payables and bank overdraft.
 Significant increases in debt ratios such as total debt ratio and debt-to-equity
ratio.
 Significant decreases in liquidity ratios such as current ratio and quick ratio.
There might be net current liabilities.

Page 15 of 31
There has been significant growth in sales revenue (50% in 2013 and 103% in 2014). This
is accompanied by significant growth in current assets, particularly receivables and
inventory. However, receivables turnover days and inventory turnover days have both
shortened from 55 to 53 days and from 138 to 83 days respectively. What is more, the
payables turnover days has shortened significantly from 34 days to 25 days due to the
increased use of bank overdraft in financing working capital needs. Bank overdraft
increased by a whopping 237% in 2014.
The company’s liquidity ratios kept dropping over the three years under review. The
current ratio dropped from 2.05:1 in 2012 to just 1.54:1 in 2014 while the quick ratio
dropped from 1.03:1 in 2012 to 0.75:1 in 2014. Besides, the ratio of long-term capital to
total assets kept reducing over the same periods. Long-term capital that stood at 73% of
total assets in 2012 had dropped to 54% of total assets. The decreases in liquidity ratio is
due to the significant increase in current liabilities, mainly due to the high increment in
bank overdraft financing. The growth in long-term capital is due to reinvestment of
profits as stated capital stood the same and medium-term loan was being amortised
over the period. These suggest that the company is financing most of the rapid growth
in sales with short-term funds rather than long-term capital.
Sales revenue is increasing rapidly, liquidity ratios are falling, long-term capital ratio is
falling, and there is significant increase in bank overdraft. On the face of it, one would
concluded that the company is overtrading. However, the ratio of long-term capital is
not yet too low to permit the conclusion that the company is trying to do too much too
quickly with too little long-term capital. If the current trends in long-term capital ratio,
sales growth, and liquidity ratios continue in the future, the company might experience
overtrading in the near future.

Measure 2012 2013 2015

Growth in sales 𝑆𝑡 − 𝑆𝑡−1 50% 103%

= × 100%
𝑆𝑡−1
Growth in trade 𝑇𝑅𝑡 − 𝑇𝑅𝑡−1 62.5% 116%
= × 100%
receivables 𝑇𝑅𝑡−1
Growth in inventory 𝐼𝑁𝑡 − 𝐼𝑁𝑡−1 93.8% 164.5%
= × 100%
𝐼𝑁𝑡−1
Growth in assets 𝑇𝐴𝑡 − 𝑇𝐴𝑡−1 155.4% 158%
= × 100%
𝑇𝐴𝑡−1
Growth in overdraft 𝑂𝐷𝑡 − 𝑂𝐷𝑡−1 237%
= × 100%
𝑂𝐷𝑡−1
Growth in equity 𝐸𝑡 − 𝐸𝑡−1 51.6% 130.8%
= × 100%
capital 𝐸𝑡−1

Page 16 of 31
 Growth in medium- 𝑀𝑇𝐿𝑡 − 𝑀𝑇𝐿𝑡−1 - 16.7% - 20%
= × 100%
term loan 𝑀𝑇𝐿𝑡−1
Inventory turnover 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑁 138 83 days
= × 365 𝑑𝑎𝑦𝑠
days 𝐶𝑂𝑆 days
Receivables turnover 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑅 55 days 53 days
= × 365 𝑑𝑎𝑦𝑠
days 𝑅𝑒𝑣
Payables turnover days 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑃 34 days 25 days
= × 365 𝑑𝑎𝑦𝑠
𝐶𝑂𝑆
Total debt ratio 𝑇𝐿 36.7% 38.3% 48.9%
=
𝑇𝐴
Long-term debt to 𝐿𝑇𝐷 16.1% 8.9% 5.4%
=
equity ratio 𝐸
Long-term capital to 𝐿𝑇𝐷 + 𝐸 0.73 0.67 0.54
=
total assets 𝑇𝐴
Current ratio 𝑇𝐶𝐴 2.05 1.78 1.54
=
𝑇𝐶𝐿
Quick ratio 𝑇𝐶𝐴 − 𝐼𝑁 1.03 0.75 0.75
=
𝑇𝐶𝐿

(b) Introduction of early settlement discount policy

Candidates are expected to match the cost of the early discount policy against the
benefit of it. The policy change is worthwhile when the benefit, measured in terms of
annual interest savings, exceeds the cost, measured in terms of the cash discount that
would be given.

Under current policy:

Current credit sales = GHS122 million
Current credit period = 40 days
Receivables turnover days = 53 days
Trade receivables, 2014 = GHS24.210 million
Trade receivables, 2013 = GHS11.210 million

Page 17 of 31
Under discount policy:
Credit sales = GHS122 million (assumed to be kept at recent
sales level)
Credit period = 40 days
Discount period = 10 days
Discount rate = 1.5%
Early payment probability =60%

Other relevant data:

Financing cost = 15%

Cash discount cost = Credit sales x Discount rate x Early payment probability
Cash discount cost = GHS122m x 1.5% x 60% = GHS1.098m

If credit policy remains unchanged, average trade receivables would be

GHS17.715m:
53
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = × 𝐺𝐻𝑆122𝑚 = 𝐺𝐻𝑆17.715𝑚
365
Or
𝐺𝐻𝑆24.210𝑚 + 𝐺𝐻𝑆11.210𝑚
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = = 𝐺𝐻𝑆17.71𝑚
2

If early settlement discount is introduced, average trade receivables would be

GHS7.353m:
𝑁𝑒𝑤 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
10 40
=( × 60% × 𝐺𝐻𝑆122𝑚) + ( × 40% × 𝐺𝐻𝑆122𝑚)
365 365

𝑁𝑒𝑤 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = 𝐺𝐻𝑆2.005𝑚 + 𝐺𝐻𝑆5.348𝑚 = 𝐺𝐻𝑆7.353𝑚

Funds that would be released every year if the early settlement discount is
introduced is GHS11.365m:
𝐹𝑢𝑛𝑑𝑠 𝑡𝑜 𝑏𝑒 𝑟𝑒𝑙𝑒𝑎𝑠𝑒𝑑 = 𝐺𝐻𝑆17.715𝑚 − 𝐺𝐻𝑆7.353𝑚 = 𝐺𝐻𝑆10.362𝑚

Interest charges that would be saved every year due to the early settlement discount
is GHS1.554:
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑠𝑎𝑣𝑒𝑑 = 𝐺𝐻𝑆10.362 × 0.15 = 𝐺𝐻𝑆1.554𝑚
Summary:
Page 18 of 31
 GHS’m
Benefit of new discount policy: Interest saved every year = 1.554
Cost of new discount policy: Cash discount allowed every year = 1.098
Net benefit of new discount policy = 0.456

Conclusion:
If the early settlement discount is introduced and 60% of accounts are settled early to
take the discount, the company’s profit will increase by GHS0.456m every year.
Therefore, management should accept the early settlement discount proposal for
implementation.

(c) Switch from financing working capital needs with bank overdraft to financing with
trade credit
If the company continues to finance working capital needs with bank overdraft, the
annual financing cost would be 15%.
If the company finances working capital needs with suppliers trade credit the
annual financing cost would be 12.3% (assuming simple interest):

d 365
Cost of trade credit = ×
100 − d t
Discount, d = 1

Effective credit period, t = 40 – 10 = 30

1 365
Cost of trade credit = × = 0.123
100 − 1 30

Conclusion:
Since the cost of financing with suppliers’ trade credit is lower than the cost of
financing with the overdraft facilities, the company should discard its current
working capital financing method and finance with trade credit.

Note:
Full credit should be given to candidates who estimate the cost of trade credit
based on compound interest:
365⁄
100 𝑡
Cost of trade credit = {[( ) ] − 1}
100 − 𝑑

Page 19 of 31
 365⁄
100 30
Cost of trade credit = {[( ) ] − 1} = 0.13
100 − 1

(d) Easing cash shortages

Steps management can take to ease cash shortages when the company cannot obtain
additional funds from external sources include the following:
1) Postpone capital investments.
2) Postpone dividend payments.
3) Accelerate collection from customers by offering incentives for early payment
(e.g. early settlement discount, increase in credit limit). This will reduce funds
tied up in working capital.
4) Reduce investment in inventory to minimise funds tied up in working capital.
5) Reverse past investment decisions by selling assets previously acquired but
are surplus to the company’s needs, or producing negative or lower returns.
Even assets that are needed can be sold and leased back.
6) Negotiate with creditors for more favourable payment terms.

EXAMINER’S COMMENTS
This covered (a) to (d) as well and covering broad areas.
The over trading aspect of the question was fairly answered well except the detailed
computation of the ratios to support that which students were expected to. Students
calculated only few ratios to back that.
The (b) aspect of the introduction of early settlement discount policy was a challenge to
students in calculating all the decision variables and coming out with the overall
decision. This was averagely answered as students were able to compute only some of
the variables. Most students could not calculate the cost of trade credit as required by
the question. This required straight forward formula calculation as most students did
not know the formula to use. The (d) aspect of the question appeared straight forward
and was fairly answered. Overall the question appeared loaded.

Page 20 of 31
QUESTION THREE:

a) Fiscal policy
i) Fiscal policy involves the use of taxation and government spending mainly to
manipulate aggregate demand with a view to influencing the economy in a
particular way. Monetary policy involves the manipulation of monetary
variables such as money supply and interest rate to achieve certain economic
targets such as reduction in inflation.
The distinction between the two is in the variables that are used to achieve the
economic target. In the case of fiscal policy, taxation and government spending
are manipulated to achieve results whilst economic variables are manipulated to
achieve the objectives of monetary policy.
ii) A contractionary fiscal policy involves increasing tax revenue while either
maintaining or cutting the level of government spending.
Adverse effects of contractionary fiscal policy on businesses include the
following:
 Reduction in sales revenue and consequently, profit: Contractionary fiscal
policy involving increases in income tax rate reduces disposable income and
thus aggregate demand falls. With other factors of demand remaining the
same, the reduction in disposable income will result in reduction in demand
for goods and services.
 Reduction in profit that can be reinvested: Increase in income tax rates will
take more cash from businesses and thus reduce the amount of cash from
operations that would be available for reinvestment. Firms will have to raise
funds from external sources with higher costs and risks.
 Restriction on flexibility in taking credit decisions: Higher sales or
consumption taxes rate (e.g. VAT rate) reduces businesses’ flexibility in
granting credit. As VAT is payable when due regardless of whether payments
have been received from customers or not, businesses that grant credit for
periods longer than the grace period for payment of consumption taxes over
the tax authority will have to pay the amount due from their own resources
or with borrowed funds.
 Reduction in profit of firms facing price elastic demand: When rates of
indirect taxes such as VAT and excise duty are increased, firms facing price
elastic demand will have to either, absorb the additional cost and risk lower
profits or pass on the additional cost to consumers in higher price to risk
lower demand. In either case, the profit of such businesses will drop.
Page 21 of 31
  Reduction in loanable funds: Contractionary fiscal policy reduces disposable
income, and households will have little left to save in banks and/or invest in
securities. This reduces the amount of surplus funds from households that
can be channelled to businesses. However, if the reduction in aggregate
demand results in reduction in inflation, interest rates might drop and cost of
capital will be lower.

i) Valuation of Papa’s Skin Ltd

i) Appropriate required rate of return on the equity stock of Papa’s Skin Ltd

The average required rate of return on industry listed stocks is 16%. With a
marketability risk premium of 7 percentage points, the required rate of return on
the equity stock of Papa’s Skin Ltd should be 23%:

Appropriate required return on equity = Industry return on equity + Marketability risk premium

Appropriate required return on equity = 16% + 7% = 23%

ii) Range of consideration for 40% stake in Papa’s Skin Ltd

Net assets method:
GHS’000
Property, plant and equipment 52,400
Current assets (25,300 – 80 – 95) 25,125
Total assets 77,525
Long-term borrowings (9,100)
Current liabilities (11,100)
Net assets 57,325

𝐺𝐻𝑆57,325
𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = 𝐺𝐻𝑆28.66
2,000

The P/E ratio method:

Using the P/E ratio method, the value per share is estimated as under:
Value per share = Justified P/E ratio x EPS
The earnings per share (EPS) of Papa’s Skin Ltd is GHS4.8:

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑡𝑡𝑟𝑖𝑏𝑢𝑡𝑎𝑡𝑏𝑙𝑒 𝑡𝑜 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐺𝐻𝑆9,600

𝐸𝑃𝑆 = =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 2,000
= 𝐺𝐻𝑆4.8

Page 22 of 31
The P/E ratio for the purpose of valuing an unlisted company could be one-half or two-
thirds of the industry average P/E ratio. If we take a figure equal to 50% of the industry
P/E ratio for the purpose of valuing Papa’s Skin:
Justified P/E ratio = 10 x 0.5 = 5
Value per share = GHS4.8 x 5 = GHS24
Constant growth dividend discount model:
When dividend will grow at a constant rate, the constant growth DDM can be used to
estimate the value of equity as under:
𝐷𝑃𝑆0 (1 + 𝑔)
𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =
𝑘𝑒 − 𝑔

Recent dividend per share, DPS0 is GHS0.96:

𝐺𝐻𝑆1,920
𝐷𝑃𝑆0 = = 𝐺𝐻𝑆0.96
2,000

Required return on equity, Ke = 23% (or the figure candidate obtained in (b) (i) above).

Growth in dividend, g = 5%
𝐺𝐻𝑆0.96(1 + 0.05)
𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = 𝐺𝐻𝑆5.6
0.23 − 0.05
Range of suitable considerations:

(a) (b) (c) (d)

Method Value per share Total equity value Consideration for

40%
(b) x 2 million
(c) x 40%

Net assets method GHS28.66 GHS57,320,000 GHS22,928,000

P/E ratio method GHS24 GHS48,000,000 GHS19,200,000

Dividend valuation GHS5.6 GHS11,200,000 GHS4,480,000

method

Page 23 of 31
EXAMINER’S COMMENTS
The (a) aspect of the question appeared straight forward but students generally
provided average answers showing their limited scope of studies.
The (b) aspect was poorly answered as it covered 3 areas of computation from different
areas for the decision. The question was standard but coverage was wider for a sub
question making it difficult for the students to score full marks for all the computations.
Students were able to cover certain aspects of the question.

QUESTION FOUR

(a) Capital structure decision at Moore Plastics Ltd

i) Reasons why most managers use financing strategies that follow the pecking
order include the following:
 Easier access to funds: Managers prefer sources of finance that are relatively
easier to access to those that are relatively difficult to access. Retained
earnings, the easiest to access and use, is first choice while new equity offers,
the most difficult to access and use, is the last resort.
 Issue costs: Managers prefer sources with lower issue costs to those with
higher issue costs. There are no issue costs when retained earnings is used,
that is why it is the most preferred. Issue costs relating to debt offers are
lower than those relating to equity offers. Therefore, debt offers are preferred
to equity offers.
 Investors’ preference for safer securities: As debt stocks offer more secured
income streams to investors than equity stocks offer, it is easier for firms to
raise funds through debt offers than equity offers.
 Signalling effect: Managers believe debt issue has a better signalling effect
than equity offer. Investors may interpret debt issue to mean that managers
are confident that the investments will produce profit. Equity offer, on the
other hand, may be interpreted by investors as lack of management
confidence in the investment producing profits. Thus, managers prefer debt
offer to equity offer.

ii) Factors to consider when designing capital structure include the following:
 Business risk: Business risk refers to the risk inherent in business operations
in the absence of debt financing. A higher business risk implies a small drop
in sales revenue will cause operating profit to drop so low that the company
cannot meet its interest obligation. If Moore Plastic Ltd faces high business
risk, the new capital structure should have more equity than debt. If business
risk is low, a structure of more debt than equity is reasonable.
Page 24 of 31
  Financial risk: Financial risk refers to the additional risk shareholders face as
the company uses debt capital. When financial risk is already high, the
proportion of equity should be more than that of debt in the new structure.
 Tax position: The tax-benefit from the use of debt financing is high when the
company falls into a higher tax bracket. If the company is in a higher tax
bracket, a financing structure with more debt than equity would be
reasonable.
 Clientele effect: An investor would prefer a particular capital structure to
another. So when redesigning capital structure, directors should consider
how present and prospective investors will react to the new capital structure.

(b) Appropriate cost of capital for Pusher Mining Ltd.’s new oil project

The appropriate cost of capital for the new oil project is the project’s specific cost
of capital. As the company will finance with both equity and debt, this cost of
capital should be the project specific WACC.

𝐸 𝐿 𝐵
𝑊𝐴𝐶𝐶 = 𝑘𝑒 + 𝑘𝑙𝑡 + 𝑘𝑏𝑡
𝑉 𝑉 𝑉
Where

E = market value of equity

L = market value of bank loans

B = market value of bonds

V = market value of total capital

Klt = after-tax cost of bank loans

Kbt = after-tax cost of bonds

Ke = cost of equity

Page 25 of 31
 After-tax cost of bank loans:

Given as 14.5%

After-tax cost of bonds, Kbt:

Redemption value = GHS100

Conversion value = Number of shares x Value of share on conversion date

Conversion value = 10 shares x GHS5.5 (1+0.08)10 = 10 shares x GHS11.87 =

GHS118.7

Since the conversion value is higher than the redemption value, bondholders will
opt for conversion of their bonds.

Therefore, the cost of the bonds is the IRR of the market value, after-tax periodic
interests, and the conversion value.

Year Bond cash flow PV @ 10% PV @ 15%

GHS Disc Factor PV Disc Factor PV
0 -98.1 1 -98.1 1 -98.1
1-10 12 6.145 73.74 5.019 60.228
10 100 0.386 38.6 0.247 24.7
NPV = 14.24 NPV = -13.172

14.24
𝑘𝑏𝑡 = 𝐼𝑅𝑅 = 0.1 + (0.15 − 0.1) ( ) = 0.1 + 0.026 = 0.126
14.24 + 13.172

Cost of equity, ke:

Equity beta of Cargo Oil Ltd, βe = 1.8

Ungeared (asset) beta of Cargo Oil Ltd is 1.2:

𝑉𝑒 𝐺𝐻𝑆150𝑚
𝛽𝑎 = × 𝛽𝑒 = × 1.8 = 1.2
𝑉𝑒 + 𝑉𝑑(1 − 𝑡) 𝐺𝐻𝑆150𝑚 + 𝐺𝐻𝑆100𝑚(1 − 0.25)

Regear the beta to reflect the capital structure of Pusher Mining Ltd as under.

𝑉𝑒 + 𝑉𝑑(1 − 𝑡)
𝛽𝑒 = × 𝛽𝑎
𝑉𝑒

Page 26 of 31
 Market value of Pusher’s equity, Ve = 40m shares x GHS5.5 = GHS220m

Market value of Pusher’s debt, Vd = Value of bank loans + Value of bonds

Market value of Pusher’s debt, Vd = GHS40m + GHS117.72m = GHS157.72m

Value of bonds = Current market price x Units of bond in issue = GHS98.1 x 1.2m =
GHS117.72

Units of bond in issue = GHS120m / GHS100 = 1.2m

Therefore the appropriate equity beta that reflects the risk of the new business and
capital structure of Pusher Mining Ltd is 1.845:

𝐺𝐻𝑆220𝑚 + 𝐺𝐻𝑆157.72𝑚(1 − 0.25)

𝛽𝑒 = × 1.2 = 1.845
𝐺𝐻𝑆220𝑚
The appropriate cost of equity for the new business can be estimated using the CAPM
as under.

𝑘𝑒 = 0.14 + 1.845(0.2 − 0.14) = 0.14 + 0.1107 = 0.2507

The WACC is 20.1%:

𝐺𝐻𝑆220𝑚 𝐺𝐻𝑆40𝑚 𝐺𝐻𝑆117.72𝑚

𝑊𝐴𝐶𝐶 = × 0.2507 + × 0.145 + × 0.126
𝐺𝐻𝑆377.72𝑚 𝐺𝐻𝑆377.72 𝐺𝐻𝑆377.72
= 0.201

Conclusion:

The appropriate cost of capital Pusher Mining Ltd should use to appraise the new oil
project is 20.1%. This reflects the business risk associated with the new operation in the
oil industry and the financial risk associated with Pusher’s financing structure.

EXAMINER’S COMMENTS
The (a) aspect of the question was one area students fairly answered well. A straight
forward question requiring application of the knowledge in the subject area. Some
students however still struggled and wrote wide and general but not addressing the
requirement of the question.
The (b) aspect of the question was one of the worst answered areas in the paper.
Student deviated and some found it very difficult to comprehend the question. The
Page 27 of 31
question appeared ambiguous to students requiring a lot of detailed calculations as a
sub question. The calculation of ungeared beta posed a big challenge to a lot of the
students. There was no balance between the difficult nature of the question and extent
of loading in the question. The question was difficult and loaded at the same time for
the students.
QUESTION FIVE:

(a) AD Ventures’ currency risk exposure

i) Differences between forward and futures
The differences between forward and futures are summarised in the table below:

Point of distinction Futures Forward

Trading platform Exchange traded Over-the-counter

instruments (i.e. open transactions
market)
Contract sizes Standardised contract sizes Tailored contract sizes

Contract maturity Standardised maturity Tailored maturity dates

dates dates
Settlement/close out Flexible close out dates Fixed date of settlement
dates
Trading of the Position may be closed out Underlying asset is
underlying asset without trading the typically traded
underlying asset
Collateral Performance bond (or Typically, no collateral is
collateral) is required in the required
form margin deposits
Dealer/mediators The exchange profits from The dealer benefits from
margin fees paid by contracting the bid-ask spread
parties
Contract price Futures price is marked to Forward rate is set on
adjustments market contract date, and
remains fixed irrespective
of changes in market
conditions

Page 28 of 31
 ii) Type of currency risk AD Ventures is facing
Explanation of the three types of currency risk exposures:
A firm that engages in international business transactions faces transaction risk
when it has contractual cash flows that are fixed in the foreign currency and the
exchange rate might change over the contract period. For instance, transaction risk
exists when value of imports and exports are fixed in the foreign currency and there
is movement in the exchange rate between the invoice date and settlement date.
Translation risk is when an organisation will suffer exchange losses when the
results of its foreign branches and subsidiaries are translated into the home
currency.
Economic risk refers to the effect of exchange rate movement on the international
competitiveness of an organisation. It refers to the present value of longer-term cash
flows. It exists when an organisation faces competition from domestic
producers/traders in the foreign country or local importers in the home country.
Analysis of AD Ventures case:
By engaging in the import transaction that will be settled in the future, AD Ventures
faces contractual cash flow (here the obligation to pay EUR540,000). Moreover, the
contractual cash flow is fixed in the foreign currency, the euro.
Conclusion on risk type:
With respect to the tomato import from Italy, AD Ventures is facing transaction
exposure to currency risk.

iii) Disadvantages of hedging with futures hedge

 Contract size cannot be tailored to the exact requirements the investor. This means
that the investor’s underlying exposure may not be covered effectively, resulting in
hedge inefficiency.
 Contract maturity date cannot be tailored to synchronise with maturity date of
underlying exposure. For instance, AD Ventures’ euro obligation falls due in
January 2016 but the available contract matures in February 2016. This results in
hedge inefficiency.
 Basis risk is inherent in futures hedge. There is the risk that the futures price may
move by a different amount from the price of the underlying asset.
 Unlike options, the investor has an obligation to either trade the underlying asset or
take an opposite position to close out. This means that the investor does not have the
flexibility to take advantage of favourable price movements in the spot market.
 Unlike forwards, futures requires opening and maintenance of a margin account
which involves deposit of cash or cash equivalent.

Page 29 of 31
 (b) Term structure of interest rate
Reasons why interest rates on debt securities or loans are different for different
maturity periods include the following:
 Liquidity preference theory: Explains that the yield curve is likely to be upward
sloping (i.e. lower yield for shorter maturities and higher yield for longer maturities)
as investors prefer having cash sooner to having cash later. Therefore, investors
want a higher compensation to invest in longer-term security/loans, which has
much of their cash flows occurring later; and lower compensation to invest in short-
term security/loans, which has much of their cash flows occurring sooner. In
conclusion, the longer term interest rates tend to be higher than shorter term interest
rates, and the yield curve slopes upwards.
 Expectations theory: Explains that interest rates reflect expectations of future
changes in interest rates. When interest rates are expected to rise in the future,
longer-term interest rates will be higher than shorter-term interest rates, and the
yield curve will slope upward. When interest rates are expected to fall, shorter-term
interest rates may be higher than longer-term interest rates, and the yield curve
becomes downward sloping.
 Market segmentation theory: Explains that the slope of the yield curve will reflect
conditions in the different segments of the market. Suppose the debt market is
segmented into short-term debt market and long-term debt market. If during a
period, there are few lenders who are willing to offer long-term loans but more
borrowers who demand long-term loans, there will be shortage of funds in the
market for long-term funds and excess fund in the market for short-term funds.
Consequently, interest rates on long-term loans will be higher than rates on short-
term loans, and the yield curve will be upward sloping.
 Government policy: Government may influence level of interest rate in the
economy through its monetary policy. A policy with the effect of keeping interest
rates relatively high may force short-term interest rates higher than long-term rates.
For instance, as the Government of Ghana borrows more through the 182-day
Treasury bill than the 1-year note, the annualised interest rate on the 182-day bill is
higher than the annual rate on 1-year note as of August 28, 2015.

EXAMINER’S COMMENTS
This question was straight forward for students to understand and answer.
This question was well answered by most students and the most attempted question by
most students.

CONCLUSION
The paper was generally a very difficult paper although some questions were generally
Standard and the amount of work required by the students was commensurate with the
Page 30 of 31
allotted time but some appeared loaded as already highlighted in the question by
question analysis. Below are some of the recommendations to improve the poor
performance in financial management;
 More questions and answer bank and guide lines should be provided by the
Institute and other accredited tuition centres
 ICA tuition and revision centres should incorporate exam comprehension and
answering techniques as part of their revision lectures and kits to better guide
students preparing to write the exams
 Explore the possibility of implementing web based or electronic based tuition
and revision centres for students leaving outside the Accra area
 Implementation of mock like exams by the accredited tuition centres to help
prepare the students to have the feel of the exams before the main exams and
feedback given at individual level on what went well and what didn’t go well in
the mock or pre exam test even if it is at an affordable fee for students
 Re evaluation of the quality of the students and admission requirements for the
Institute.

Page 31 of 31
 MAY 2017 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS & MARKING SCHEME

EXAMINER’S GENERAL COMMENTS

The level of preparations appeared better. There was an improvement in the answers
given. This demonstrates that students prepared adequately. Basic Finance terms and
terminologies were responded to quite well and most answers provided exhibited
some level of basic fluency in Finance terminologies. Majority of candidates
concentrated their time and answers more on the straight forward questions especially
the written ones that fetched them the maximum marks to improve their chances of
passing.

STANDARD OF PAPER
The standard of the Financial Management paper for May 2017 exams was generally
satisfactory, balanced and well spread. Based on the performance of the students, the
questions were generally understood and well answered in most cases by students.
Feedback from other examiners and overall pass rate by students were consistent with
this observation.

The question paper was well spread and cutting across most subject areas. Both
quantitative and theory aspect of the exams were covered with the theory questions
considered straight forward for well-prepared students to handle without any
difficulties. The questions appeared precise, unambiguous and measured up to the
standard expected at level 2 of the examination except questions 4 and 5 which
students found to be a bit ambiguous. No typographical errors were noticed and no
errors were found in the questions. The area requiring improvement was the provision
of alternative solutions in the marking scheme for questions that could be answered
from a different perspective outside the marking schemes provided.

No sub-standard question was noticed in the paper and all questions were found to
be of good standard to meet the standards expected at that level. Mark allocations
conformed to the syllabus weightings and in few cases where it was observed not to
be fairly allocated, they were slightly modified at the co-ordination level to ensure a
balance in the allocation.

PERFORMANCE OF CANDIDATES
The performance of the students was the best in recent times. Half of students passed
the paper compared to the prior highest of 33% and less than 10% historically for the
paper. This was a remarkable improvement over the recent past sittings and the best
performance in recent memory. It was further observed that there was a general
improvement in pass rate across all the centers compared to the past with
Accra/Kumasi/Cape coast centers showing better performance. This can be partially
attributed to the nature of questions set and improvement in the level of teaching and
preparations generally. Students also maximised the marks on the straight forward
theory and quantitative questions to score the critical marks needed to achieve pass

Page 1 of 19
rate to balance the low marks averagely recorded in the question 4 and 5 which were
the worst answered questions.
NOTABLE STRENTHGS AND PERFORMANCE OF STUDENTS
The 50% of students who did well exhibited the following strengths:
• Reading and understanding of the questions
• Spending more time on the first three questions that carried the most marks (70
marks) which were a bit better and straight forward.
• Spending less time on the last 2 questions which were difficult but carried only
30 marks of 15 each.
• Well planned responses to the questions in line with the requirements of
questions
• Improvement in handwriting making reading and marking easier and better
• Exhibited a good level of preparation in both quantitative and written
questions.
• The strengths spread better by more students in this sitting than the prior
sittings where it was limited to few students.
• Ability to think broad and respond to questions that required innovative
thinking

Observed weaknesses demonstrated by students

• Some level of weak understanding of Finance principles by some students was
still noticed although this was better than previous sitting.
• Spending more time on difficult questions that carried low marks
• Poor numbering of questions and spreading answers erratically across so many
pages making marking difficult for examiners
• Wrong numbering of answers to questions making it difficult for examiners
• So much irrelevant answers provided especially written questions making
answers so long and unnecessary
• Poor handwriting and faded pens still persisted.

Page 2 of 19
QUESTION ONE

a) Bhim is a not-for-profit non-governmental organisation aimed at supporting alleged

witches to have an empowered livelihood. The organisation is developing a proposal to the
Ministry of Gender and Social Protection to secure funding to improve basic healthcare and
sanitation at three alleged witches’ camps. They have consulted you to help them develop
the section on value for money (VfM) in their proposal.

Required:
i) Briefly explain the following value for money concepts :
 Economy
 Efficiency
 Effectiveness
(6 marks)

ii) Compare and contrast value for money and corporate value maximization. (4 marks)

b) One of the important sustainability requisite for the accelerated development of an

economy is the existence of a dynamic financial market. Financial markets can be found in
nearly every nation in the world. Some are very small, with only a few participants, while
others, like the New York Stock Exchange (NYSE) and the forex markets, trade trillions
of dollars daily.

Required:
What is a financial market? (1 mark)

c) Explain the difference between the following financial markets;

i) Debt market and Equity market. (3 marks)
ii) Money market and Capital market (3 marks)
iii) Forex market and Interbank market (3 marks)

(Total: 20 marks)

QUESTION TWO

a) SAFOO Ltd has in issue 5 million shares with a market value of GH¢ 3.81 per share. The
equity beta of the company is 1.2. The yield on short- term government debt is 23% per
year and equity risk premium is 5% per year. The debt finance of SAFOO Ltd consists of
bonds with a total book value of GH¢2 million. These bonds pay annual interest before tax
of 25%. The par value and market value of each bond is GH¢100. The Company pays tax
at 25%.

Required:
Calculate SAFOO Ltd Weighted Average cost of Capital. (10 marks)

b) Choosing an appropriate source of business finance can be a difficult and time-consuming

task. This is due to the sheer amount of funding options available. Financing can come in
the form of debt or investment, and finance terms can vary significantly. The criteria and

Page 3 of 19
 implications of each source require critical analysis before proceeding, and it is essential to
weight the cost versus benefits of each source before making a decision.

Required:
i) Discuss FOUR factors that a company should consider when choosing a source of
debt finance. (6 marks)

ii) Explain THREE factors that may be considered by providers of finance in deciding
how much to lend to a company. (3 marks)

c) A company with 20 million shares in issue announces a 2 for 5 rights issue at a price of
GH¢3 per share. The market price of the existing shares before the rights issue is GH¢3.70.

Required:
i) What is the theoretical ex-right price? (3 marks)
ii) What is the theoretical value of the rights? (3 marks)

(Total: 25 marks)

QUESTION THREE

a) Payback method refers to the period of time it takes for the cash flows to cover the initial
cost of investment or recoup the initial cost of investment. The period is usually calculated
in years.

Required:
Identify TWO advantages and TWO disadvantages of using the payback method in
investment appraisal? (4 marks)

b) DÉCOR Ltd is analyzing the purchase of a new machine to produce product Z. The machine
is expected to cost GH¢2,000,000. Production and sales of product Z is forecast as follows:

Year 1 2 3 4
Production & Sales (units/year) 70,000 106,000 150,000 72,000

The current selling price is GH¢30 per unit and is expected to increase by 5% a year. The
current variable cost is GH¢18 per unit and is expected to increase by 6% per year. Fixed
cost will remain the same but increase in working capital is required. Analysis of historical
data of the levels of working capital of product Z indicates that, at the start of each year
investment in working capital will need to be 10% of sales revenue of that year.

The company pays tax at 25% per year in the year in which taxable profit occurs. The tax
liability is reduced by the capital allowance on the machinery and DÉCOR Ltd can claim
on straight line basis over the four year life of the proposed investment (capital allowance
rate of 25% per anum). The new machine will have zero scrap value at the end of the four
years. The cost of capital is at 15% per year.

Page 4 of 19
 Required:
Calculate the Net Present Value of the proposed investment and advice whether the
proposed investment should be undertaken. (11 marks)

c) An American company sells goods to a Ghanaian buyer for US$280,000 when the
exchange rate is $1 = GH¢4.20. The Ghanaian buyer is allowed three months’ credit, and
when the American company eventually receives the US dollars three months later, and
exchanges them for dollars, the exchange rate has moved to $1 = $4.60.

Required:
i) What was the foreign exchange loss to the Ghanaian buyer? (3 marks)
ii) Explain Currency risk in relation to the above. (2 marks)
iii) Explain Transaction risk in relation to the above. (2 marks)
iv) What will be the effect of the above on the company’s trading profits? (3 marks)

(Total: 25 marks)

QUESTION FOUR

a) Factoring and Invoice Discounting are both financial services that can release the funds
tied up in your unpaid invoices, involving a provider who agrees to advance money against
outstanding debtor balances. However, factoring is not the same as invoice discounting.

Required:
Differentiate between factoring and invoice discounting. (5 marks)

b) ATA Ghana Ltd is a Company in Ghana engaged in the trading of commodities. The annual
sales are at GH¢ 24 million. The average age of debtors is one month and the percentage
of bad debts is 1%.

A new Marketing Director has been hired by the Company to improve its sales. The new
Marketing Director proposed that sales could be increased up to GH¢ 30 million if new
customers were taken on. Taking on new customers will lengthen the average credit period
to 2 months and increase bad debts to 1.5% of sales.

The Finance Manager provided that, variable cost is 70% of the selling price and the
Company’s cost of capital is 20%.

Required:
Advise whether the Company should take on the new customers. (10 marks)

(Total: 15 marks)

Page 5 of 19
QUESTION FIVE

a) Recent financial information of FCH Bank Ltd. a listed company, is as follows:

GHȻm GHȻm
Profit after tax (earnings) 66.6
Dividends 40.0
Statement of financial position information
Non-current assets 595
Current assets 125
Total assets 720
Current liabilities 70
Equity
Ordinary share (GHȻ1 nominal) 80
Reserves 410 490
Non current liabilities
6% Bank loan 40
8% Bonds (GHȻ100 nominal) 120 160
720

Financial analysts have forecasted that the dividends of FCH Bank Ltd. will grow in the
future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit
after tax (earnings) of the company, which is 5% per year. The finance director of FCH
Bank Ltd. thinks that, considering the risk associated with expected earnings growth, an
earnings yield of 11% per year can be used for valuation purposes.

FCH Bank Ltd. has a cost of equity of 10% per year and a before-tax cost of debt of 7%
per year. The 8% bonds will be redeemed at nominal value in six years’ time. FCH Bank
Ltd. pays tax at an annual rate of 30% per year and the ex-dividend share price of the
company is GH¢8·50 per share.

Required:
Calculate the value of FCH Bank Ltd. using the following methods:
i) Net asset value method; (3 marks)
ii) Dividend growth model; (3 marks)
iii) Earnings yield method. (3 marks)

b) Kantamanso Ltd which operates in the Distribution sector in Ghana has provided the
following information for the year ended 31 December 2015

No of Shares Market Value

(GH¢)
10% cum preference shares 18,000 30
Ordinary Shares 15,000 45

The proposed dividend for the year is GH¢0.3 for the preference shares and GH¢0.45 for
ordinary shares each. The company’s chargeable profit was GH¢40,000 and the profit
before taxation was GH¢38,000. The Tax rate is 25% for both the Company and the
individual.
Page 6 of 19
 Required:
Calculate in respect of ordinary shares:
i) Dividend cover (2 marks)
ii) Earnings per share (2 marks)
iii) Price/earning ratio (2 marks)

(Total: 15 marks)

Page 7 of 19
 MARKING SCHEME
QUESTION ONE
a) Bhim
(i) Value for money (3Es/4Es)
Value for money (VfM) is the process of ensuring that resources applied to achieve
optimal results in the most sustainable way and also for the right target. The key
elements of value for money are
 Economy
 Efficiency
 Effectiveness
 Equity
The three key elements (sometimes referred to as the 4Es) are discussed below;
 Economy – this measures the acquisition of inputs at the highest quality, at the
lowest cost and within acceptable time for achieving a given output
 Efficiency – this measures the amount of resources used to achieve a giving
output. It also considers the proficiency and appropriateness of the process used
for converting the input into output.
 Effectiveness – this measures the extent to which stated objectives are achieved,
and to the extent that
 Equity – ensuring fair distribution that targets the needs of vulnerable groups and
most deprived entities.
(2 points for any element well explained up to a total of 3 points=6 marks)
ii) Similarities and differences between VfM and value maximization
Similarities
 VfM and value maximization are both corporate objectives which can be used to
measure performance of managers.
 As performance measure benchmark, they ensure resources are utilized efficiently
for the acquisition of inputs to yield best results.
 Achieving VfM and ensuring corporate value maximization all have positive social
impact
(Any 2 points for 2 marks)
Differences
 VfM is an objective for not-for-profit entities whereas value maximization is
emphasized in profit making entities
 Whereas VfM considers social welfare at large, value maximization focuses on the
interest of the shareholders (few owners of the business)
 VfM may sacrifice economic benefit for overall social good, especially for
vulnerable groups but value maximization focuses on economic returns to the
owners for every resource utilised.
(Any 2 points for 2 marks)

Page 8 of 19
b) A financial market is a broad term describing any marketplace where buyers and
sellers participate in the trade of assets such as equities, bonds, currencies and
derivatives. Financial markets are typically defined by having transparent pricing,
basic regulations on trading, costs and fees, and market forces determining the prices
of securities that trade. (1 mark)
c)
i) Equity markets allow investors to buy and sell shares in publicly traded
companies. They are one of the most vital areas of a market economy as they
provide companies with access to capital and investors with a slice of ownership
in the company and the potential of gains based on the company's future
performance.

Debt market is where an investor loans money to an entity (corporate or

governmental), which borrows the funds for a defined period of time at a fixed
interest rate. Bonds which are mostly used in debt markets are used by companies,
municipalities, states and U.S. and foreign governments to finance a variety of
projects and activities. Bonds can be bought and sold by investors on credit
markets around the world. This market is alternatively referred to as the credit or
fixed-income market. It is much larger in nominal terms that the world's stock
markets. (3 marks)

ii) The money market is a segment of the financial market in which financial
instruments with high liquidity and very short maturities are traded. The money
market is used by participants as a means for borrowing and lending in the short
term, from several days to just under a year. Money market securities consist of
negotiable certificates of deposit (CDs), banker's acceptances, commercial paper,
municipal notes, federal funds and repurchase agreements (repos). Money market
investments are also called cash investments because of their short maturities.

A capital market is one in which individuals and institutions trade financial

securities. Organizations and institutions in the public and private sectors also
often sell securities on the capital markets in order to raise funds. Any government
or corporation requires capital (funds) to finance its operations and to engage in
its own long-term investments. To do this, a company raises money through the
sale of securities - stocks and bonds in the company's name. These are bought and
sold in the capital markets. (3 marks)

iii) The interbank market is the financial system and trading of currencies among
banks and financial institutions, excluding retail investors and smaller trading
parties. While some interbank trading is performed by banks on behalf of large
customers, most interbank trading takes place from the banks' own accounts.

The forex market is where currencies are traded. The forex market is the largest,
most liquid market in the world with an average traded value that exceeds $1.9
trillion per day and includes all of the currencies in the world. The forex is the

Page 9 of 19
 largest market in the world in terms of the total cash value traded, and any person,
firm or country may participate in this market. (3 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
This question was a total theory or essay question that centred on the value for money
concept (VFM), and various aspects of financial markets. Almost all students
attempted this question and it was straight forward and generally well answered. The
students optimised marks in answering this question which carried a total of 20 marks
from (a) to (c). It was one the questions that contributed to improved pass rate in this
sitting.

All average students got a pass in this question and good students scored excellent
mark boosting the chances of obtaining a pass rate in this paper.

QUESTION TWO
(a) Calculation of weighted average cost of capital.

Cost of equity = 23 + (1.2 x 5) = 29%.

The company’s bonds are trading at par and therefore the before tax cost of debt is the
same as the interest rate on the bonds which 25%.

After tax cost of debt = 25% x (1-0.25) = 18.75%.

Market value of equity = 5m x 3.81 = GH¢ 19.05 million

Market value of debt is equal to its par value of GH¢ 2 million.

Sum of Market value of equity and debt = 19.05 million + 2 million = GH¢ 21.05
million.

Weighted Average Cost of Capital (WACC) = (0.29 X 19.05/21.05) + (0.1875 X 2/21.05)

= (0.2900 X 0.905) + (0.1875 X 0.095)
= 0.2625+0.178
= 0.2803 or 28.03%
(10 marks)
b)
i) Factors to consider when choosing source of debt finance
 Cost: both issue cost, interest rate and repayment terms
 Maturity. This should be carefully matched with the cash flow structure and also
flexibility of short term debt against long term debt
 Financial risk. Debt increases gearing and hence financial risk of the company and
how investors would view that.

Page 10 of 19
 Availability of financing. This depends on size of borrowing relative to the size of
the firm, relationship with bankers and other financiers
(4 points for 6 marks)

ii) Factors to consider by providers of finance

 Security. Are there available assets to be used to secure exposure? The size of
debt or finance depends also on size of collateral available. Additionally,
interest rate charge by lenders is a function of whether is a secured exposure or
unsecured exposure
 Risk and ability to meet financial obligations.
 Legal restrictions on borrowing
 Management capacity and track record in the past and future expectation of
their ability to perform and survive in challenging market environments
(Any 3 points for 3 marks)

c) The theoretical ex-rights price can be calculated as follows.

i)
Market value of 5 existing shares (5 × GH¢3.70) 18.50
Issue price of 2 shares in the rights issue (2 × GH¢3.00) 6.00
Theoretical value of 7 shares 24.50
Theoretical ex‐rights price (= GH¢24.50/7) GH¢3.50
(3 marks)
ii) The value of rights
In theory, the holder of five shares in the company in the previous example could buy
two new shares in the rights issue for GH¢3 each, and these two shares will be
expected to rise in value to GH¢3.50, a gain of GH¢0.50 for each new share or GH¢1.00
in total for the five existing shares.
We can therefore say that the theoretical value of the rights is:
GH¢0.50 for each new share issued, or
GH¢0.20 (GH¢1.00/5 shares) for each current share held.
(3 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
Question 2 carried a total of 25 marks and one of the 2 questions that carried the
highest allocated marks covering both theory and calculations. It consisted (a) to (c).
The (a) part concentrated on the calculation of weighted average cost of capital
expecting students to calculate for both equity and debt separately before determining

Page 11 of 19
the weighted average cost. This carried 10 marks and most students scored the
maximum marks.

The (b) covered factors considered by both providers and users of funds in making
lending or borrowing decision which was straight forward question requiring
straight forward answers which was well answered.

The (c) aspect also covered rights issue with the students expected to calculate the
theoretical ex-right price and the value of the right. This was again well answered
except a few students who couldn’t score the maximum marks.

Overall it was an excellent performance with the highest 25 Marks. This also
contributed significantly to the high pass rate.

QUESTION THREE
(a)

Advantages of Payback:
 Simple and easy to use
 It gives indication of the liquidity. The earlier the payback period the better
the liquidity
 It broadly measures the risk of the project. The earlier the payback period the
better the risk
 Is faster to compute
(2 points for 2 marks)

Disadvantages:
 It ignores the time value of money
 Ignores the cash flows after the payback period and may discriminate against
projects that have significant cash flows after the payback period
 It ignores the residual value and total economic life of the project
 Determination of the payback period upfront could be subjective and
discretionary
 It measures mainly recovery of capital and not profitability of the project
(2 points for 2 marks)

Page 12 of 19
b)
In GH¢
Year 0 1 2 3 4
Sales Revenue 2,100,000 3,339,000 4,962,000 2,500,560
Variable cost (1,260,000) (2,022.480) (3,033,000) (1,543,680)
Contribution 840,000 1,316,520 1,929,000 956,880
Capital Allowance (500,000) (500,000) (500,000) (500,000)
Taxable profit 340,000 816,520 1,429,000 456,880
Tax @ 25% (85,000) (204,130) (357,250) (114,220)
Profit after tax 255,000 612,390 1,071,750 342,660
Capital Allowance 500,000 500,000 500,000 500,000
After tax cash flows 755,000 1,112,390 1,571,750 842,660

Initial Investment (2,000,000)

Working Capital (210,000) (123,900) (162,300) 246,144 250,056
Net cash flow (2,210,000) 631,100 950,090 1,817,894 1,092,716
Discount factor @ 15% 1 0.8696 0.7561 0.6575 0.5718
Present value (2,210,000) 548,805 718,363 1,195,265 624,815
NPV 877,248

The decision is to recommend that the project be undertaking based on the positive
NPV results. This will add value to share holders’ wealth.
(11 marks)
ALTERNATIVE SOLUTION TO QUESTION 3B USING YEAR 0 (ZERO) AS THE
CURRENT YEAR
Year 0 1 2 3 4
Selling Price 30 30 30 30 30
Inflation (1+g)^n 1.05 1.10 1.16 1.22
31.500 33.08 34.73 36.47

Sales Units 70,000 106,000 150,000 72,000

Sales Value (GH¢) 2,205,000 3,506,480 5,209,500 2,625,840

VC/unit 18 18 18 18 18
Inflation (1+g)^n 1.06 1.12 1.19 1.26

Page 13 of 19
 19.08 20.22 21.44 22.72

Total VC 1,335,600 2,143,320 3,216,000 1,635,840

Working Capital (10%*Sales) 220,500 350,648 520,950 262,584

Working Capital (220,500) (130,148) (170,302) 258,366 262,584

Investment Cost 2,000,000 2,000,000 2,000,000 2,000,000

Depreciation @25% 500,000 500,000 500,000 500,000

Tax Savings on Depn.
@25% 125,000 125,000 125,000 125,000

CALCULATION OF NET PRESENT VALUE

Year 0 1 2 3 4

Sales 2,205,000 3,505,480 5,209,500 2,625,840

Total VC (1,335,600) (2,143,320) (3,216,000) (1,635,840)

Taxable Cash Flow 869,400 1,363,160 1,993,500 990,000

Tax @25% (217,350) (340,790) (498,375) (247,500)

Tax Savings on Depn. 125,000 125,000 125,000 125,000

Capital Investment

Initial Investment (2,000,000)

Working Capital (220,500) (130,148) (170,302) 258,366 262,584

Free Cash Flow (2,220,500) 646,902 977,068 1,878,491 1,130,084

Discount Factor @15% 1 0.870 0.756 0.658 0.572

Discounted Cash Flows (2,220,500) 562,805 738,663 1,236,047 646,980

NPV 963,995

The decision is to recommend that the project be undertaking based on the positive
NPV results. This will add value to share holders’ wealth.
(11 marks)

Page 14 of 19
c)
i) The original expectation would have been that the amount to payback would be
$280,000 x GH¢4.2 = GH¢1,176,000. However, during the time that it was exposed
to the currency risk, the exchange rate has moved in an adverse direction, and the
actual payments are $280,000 x GH¢4.6 = GH¢1,288,000. The ‘FX loss’ has been
GH¢112,000. (3 marks)

ii) Currency risk arises from exposure to the consequences of a rise or fall in an
exchange rate. Here, the Ghanaian company was exposed to the risk of a fall in the
value of the cedi.
Currency risk is a two-way risk, and exposure to risk can lead to either losses or
gain from movements in an exchange rate. In this example, the exchange rate could
have moved the other way. For example, if the exchange rate after three months
had been $1= GH¢4.0, the Ghanaian company would have paid GH¢1,120,000
instead of GH¢1,288,000. (2 marks)

iii) Transaction risk arises only when the settlement of the transaction (and
receipt/payment) will occur at a future date. An exposure lasts for a period of time.
Here, the exposure lasts from when the goods were sold on credit until the time
that the customer eventually pays. (2 marks)

iv) Trading profits for companies engaged in foreign trade can be significantly
affected by currency movements. When exchange rates are volatile and
unpredictable, the gain or loss on currency exchange could possibly be even bigger
than the expected gross profit from the transaction. (3 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
Question 3 was a mixture of theory and calculations. It covered (a) to (c) also with (a)
considered one of the easiest requiring students to state the advantages and
disadvantages of payback period. This was well answered by almost all students.

The (b) aspect covered NPV determination and investment decision making. This part
was averagely answered. Students understood differently the current selling price
and variable cost that were to form the basis for the projected prices and the variable
cost. Some understood the current year to be year zero and others year one and based
their projections based on their understanding of which year should be the starting
year. The examiners provided alternative solution to cover this ambiguity.

The (c) part which covered mainly currency risk and losses was well answered.

Overall this question which carried a total of 25 marks was generally well answered.

Page 15 of 19
QUESTION FOUR
a) Differences between Factoring and Invoice Discounting
 The essential difference between Factoring and Invoice Discounting lies in who
takes control of the sales ledger and responsibility for collecting payment:
With Factoring, the provider takes the role of managing the sales ledger, credit
control and chasing customers for settlement of their invoices whilst with Invoice
Discounting, your business retains control of its own sales ledger and chases
payment in the usual way.

 Another difference between Factoring and Invoice Discounting is in the area of

confidentiality: With Factoring, the customer settles their invoice directly with the
Factoring Company; so customers are more likely to be aware of your Factoring
arrangement. With Invoice Discounting, your customers still pay you directly;
there is no need for them to know that a third party is involved.
(2 points for 5 marks)
b)
Present Position: GH¢

Sales 24,000,000
30% contribution 7,200,000

Cost:
Bad debts 1% x 24,000,000 x 70% = 168,000

Cost of Debtors:
Variable cost of debtors:
24,000,000/12 x 1 = 2,000,000 x 70% = 1,400,000
Hence cost of debtors = 20% x 1,400,000 = 280,000

NB// Debtors could also be valued at selling price.

Proposed policy
Sales 30,000,000
30% contribution 9,000,000

Cost:
Bad debts 1.5% x 30,000,000 x 70% = 315,000

Cost of Debtors
Variable cost of debtors:
30,000,000/12 X 2 = 5,000,000 X 70% = 3,500,000

Hence cost of Debtors 20% = 3,500,000 x 20% = 700,000

Page 16 of 19
Assessment of New Policy by ATA Ghana Ltd.
Increased contribution (9,000,000 -7,200,000) = 1,800,000
Increased bad debts (315,000-168,000) = (147,000)
Increased cost of debtors (700,000 -280,000) = (420,000)
Net benefit 1,233,000

Decision:
The company should pursue the policy of taking in the new customers.
(10 marks)

ALTERNATIVE SOLUTION TO
QUESTION 4B

OLD POLICY
GH'000 GH'000
Sales 24,000
VC of Sales 16,800
Contribution 7,200
Cost of Debtors:
Int. Foregone
(1/12*24m*20%) 400
Bad Debt (1%*24m) 240 640
Net Contribution 6,560

NEW POLICY
GH'000 GH'000
Sales 30,000
VC of Sales 21,000
Contribution 9,000
Cost of Debtors:
Int. Foregone
(2/12*30m*20%) 1,000
Bad Debt (1.5%*24m) 450 1,450
Net Contribution 7,550

ANALYSIS
Net Contribution of New
Policy 7,550
Net Contribution of old
Policy (6,560)
Net Benefit from New
Policy 990

Page 17 of 19
 Alternatively
increased Contribution 1800

increased cost of bad debt (210)

increased financing cost
(interest) (600)
Net Benefit from New
Policy 990

Decision:
The company should pursue the policy of taking in the new customers.
(10 marks)

(Total: 15 marks)

EXAMINER’S COMMENTS
This was a mix question of both theory and calculations. The (a) portion which was on
factoring and invoice discounting was averagely answered.

The (b) portion which was on decision making on extension policy on credit sales was a
challenge to students. This was poorly answered and one of the questions poorly answered.
It however had a total of only 15 marks minimising its negative impact on students pass rate.
The standard of the question was ok.

QUESTION FIVE
a)
(i) Net asset valuation
In the absence of any information about realisable values and replacement costs, net
asset value is on a book value basis. It is the sum of non-current assets and net current
assets, less long-term debt, i.e. 595 + 125 – 70 – 160 = GH¢490 million.
(3 marks)

(ii)Dividend growth model

Total dividends of GH¢40 million are expected to grow at 4% per year and FCH Bank
Ltd. has a cost of equity of 10%. Value of company = (40m x 1·04)/(0·1 – 0·04) =
GH¢693 million. (3 marks)

(iii) Earnings yield method

Profit after tax (earnings) is GH¢66·6 million and the finance director of FCH Bank
Ltd. thinks that an earnings yield of 11% per year can be used for valuation purposes.
Ignoring growth, value of company = 66·6m/0·11 = GH¢606 million
Alternatively, profit after tax (earnings) is expected to grow at an annual rate of 5%
per year and earnings growth can be incorporated into the earnings yield method

Page 18 of 19
using the growth model. Value of company = (66·6m x 1·05)/ (0·11 – 0·05) = GH¢1,166
million. (3 marks)

b) Katamanso Ltd
(i) Dividend cover
Earnings / Dividend
= 24,600/6,750 =3.64
(2 marks)
(ii) Earnings per share

Earnings available to equity holders/no of ordinary shares

24,600/15000 = 1.64
= 0.0484
(2 marks)
(iii) Price/earnings ratio

Price per share/earning per share = 45/2.18

= 20.64
(2 marks)
(Total: 15 marks)

EXAMINER’S COMMENTS
Question 5 was the most difficult of all for students and students scored very poor
marks in this question. The poor performance was however mitigated by the total
score of 15 marks compared to 20 and 25 marks in 3 questions of the paper.

The (a) part tested students on 3 methods of valuations namely net assets method,
dividend growth method and Earnings yield method. This part received fairly better
answers than the (b) part of the question.
The (b) part expected the students to calculate dividend cover, earnings per share and
price/earnings ratio from a given data that required tax computation as well.

Students generally performed poorly in answering the question.

Overall the difficult questions carried the lowest marks of 30 marks for the question 4
and 5 whilst the straight forward questions from question 1 to 3 carried 70 marks.
This distribution still made students who concentrated on the first 3 questions that
had the marks perform better on overall basis lifting the pass rate to around 50%.

CONCLUSION
Overall performance was excellent and a significant improvement in recent times. The
question paper was fairly standard and easier relative to the prior questions. Good
performance attributable to allocation of more marks to the first 3 questions that were
straight forward.

Page 19 of 19
 MAY 2018 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

STANDARD OF THE PAPER

The standard and quality of the paper was generally satisfactory. The questions
generally covered the major subject areas and also appeared balanced for both
quantitative and essay type aspects of the syllabus. The questions were easy to
understand and apply. No difficult questions were noticed except the (a) part of
Question 2 where the dividend per share stated in the question appeared to be
unusually high relative to the price per share stated in the question creating unusual
cost of equity rates or numbers as high as over 700% which created some confusion
in the minds of students. Additionally, question 5 (b) appeared to have used
historical years to represent forecast years and to calculate the present values for
business valuation purposes.

It was also observed that generally no sub-standard questions were set in the paper
and all questions were considered normal and standard for that level. Mark
allocations appeared generally satisfactory relative to the nature of questions.

PERFORMANCE OF CANDIDATES
The performance of the students in the paper was generally better as the pass rate
improved to 36% compared to the 28% in the November exams sitting. Overall pass
rate even though improved but still required further improvement for the paper
which historically has been experiencing low pass rates.
The possible reasons for the improved performance were as follows:
 Generally better preparations by students as answers provided showed some
level of improvement.
 Improved tuition services provided especially at the Accra and Institute cantres.
 Better knowledge by students on exam preparation and questions answering
techniques.
 Better access to study materials especially the out of Accra centres.
• No evidence of copying in the exams was noticed.

NOTABLE STRENGTHS & WEAKNESSES

The over 30% students who did well exhibited the following strengths:
 Reading and understanding of the questions
 Well planned responses to the questions in line with the requirements of
questions
 Very legible handwriting making reading and marking easier and better
 Well prepared and showed strengths in both quantitative and written questions
 Avoidance of mixing different answers to different questions and scattering of
answers across difference pages mixed with answers of different questions.

Page 1 of 19
Observed weaknesses demonstrated by students
 Poor understanding of Finance principles.
 Poor exam preparation.
 Failure to comprehend the requirements of the questions.
 Wrong numbering of answers to questions making it difficult for examiners.
 Writing on areas not required by the questions.
 Poor arrangement of answers to questions with answers to some questions
scattered across different pages haphazardly.

Page 2 of 19
QUESTION ONE

a) Economist has always maintained that to increase inflation, the government ought to
implement a policy of high interest rate to dampen demand.

Required:
Identify the effects on the economy of a policy of high interest rate on expenditure and
investments. (6 marks)

b) Agency problem is pervasive and exists in practically every organization whether a

business, church, club, or government. Organizations try to solve it by instituting
measures but no organization can remedy it completely.

Required:
i) What is agency problem within the context of a limited liability company? (2 marks)
ii) Explain TWO causes of agency problem. (2 marks)
iii) Explain FOUR remedies to agency problem. (4 marks)

c) For a business, it is not necessary that profit should be the only objective; it may
concentrate on various aspects such as maximisation of share price, maximisation of
sales, capturing more market shares, return on capital employed among others, which will
take care of profitability.

Required:
Explain why maximization of a company’s share price is preferred as a financial
objective to maximization of its sales. (6 marks)

(Total: 20 marks)

QUESTION TWO

a) The Finance Director of Vista Hotel has heard that the market value of the company will
increase if the weighted average cost of capital of the company is decreased. The
company, which is listed on a stock exchange, has 100 million shares in issue and the
current ex div ordinary share price is GH¢2·50 per share. Vista Hotel also has in issue
bonds with a book value of GH¢60 million and their current ex interest market price is
GH¢104 per GH¢100 bond. The current after-tax cost of debt of Vista Hotel is 7% and
the tax rate is 30%. The recent dividends per share of the company are as follows:

Year 2006 2007 2008 2009 2010

Dividend per share 19.38 20.20 20.41 21.02 21.8
(GH¢)

The Finance Director proposes to decrease the weighted average cost of capital of Vista
Hotel and hence increase its market value, by issuing GH¢40 million of bonds at their par
value of GH¢100 per bond. These bonds would pay annual interest of 8% before tax and
would be redeemed at a 5% premium to par after 10 years.

Page 3 of 19
 Required:
i) Determine the cost of equity capital of the company. (4 marks)

ii) Calculate the weighted average cost of capital of Vista Hotel in the following
circumstances:
 before the new issue of bonds takes place; (3 marks)
 after the new issue of bonds takes place. (3 marks)

b) The Moorgate Company has issued 100,000 GH¢1 par equity shares which are at present
selling for GH¢3.00 per share. It has also issued 50,000 warrants, each entitling the holder
to buy one equity share. The warrants are protected against dilution. The company has
plans to issue rights to purchase one new equity share at a price of GH¢2 per share for
every four shares.

Required:
i) Calculate the theoretical ex rights price of Moorgate’s equity shares. (4 marks)
ii) Calculate the theoretical value of a Moorgate right, before the shares sell ex rights.
(3 marks)

c) The chairman of the company receives a phone call from an angry shareholder who owns
1,000 shares. The shareholder argues that he will suffer a loss in his personal wealth due
to this rights issue, because the new shares are being offered at a price lower than the
current market value.

The chairman assures him that his wealth will not be reduced because of the rights issue,
as long as the shareholder takes appropriate action.

Required:
Prepare a statement showing the effects of the right issue on this particular shareholder’s
wealth, assuming:
i) He sells all the rights. (3 marks)
ii) He exercises one half of the rights and sells the other. (3 marks)
iii) He does nothing. (2 marks)

(Total: 25 marks)

Page 4 of 19
QUESTION THREE

a) Okechukwu Ltd is financed by three types of capital:

i) 1 million 50p ordinary shares each having current market value of GH¢5.20 cum div. The
current dividend, which is due to be paid shortly, is 20p per share. The dividend has
grown steadily in the past at a compound annual rate of 15% and is generally expected to
continue doing so indefinitely.
ii) 200,000 GH¢1 irredeemable 8% preference shares, each having a current market value of
50p ex. Div.
iii) GH¢2 million 10% debentures, redeemable in 20 years at a price of 110. The current
market value is 80 ex int.

Okechukwu is considering a new project having the same risk characteristics as existing
projects, which would require an immediate outlay of GH¢150,000 and would produce
annual net cash inflow of GH¢30,000 indefinitely.

Required:
Evaluate the viability of the new project using appropriate computations.
(15 marks)

b) Foreign currency risk can be managed, in order to reduce or eliminate the risk. Measures
to reduce currency risk are known as hedging.

Required:
i) Explain Transaction and Economic Exposure. (5 marks)
ii) Explain FIVE ways of mitigating transaction exposure. (5 marks)

(Total: 25 marks)

QUESTION FOUR

Adjaye Ltd has current sales of GH¢1.5m per year. Cost of sales is 75 per cent of sales
and bad debts are one per cent of sales. Cost of sales comprises 80 per cent variable costs
and 20 per cent fixed costs, while the company’s required rate of return is 12 per cent.
Adjaye Ltd currently allows customers 30 days credit, but is considering increasing this to
60 days credit in order to increase sales.

It has been estimated that this change in policy will increase sales by 15 per cent and bad
debts will increase from one per cent to four per cent. It is not expected that the policy
change will result in an increase in fixed costs and creditors and stock will be unchanged.

Required:
Advice whether Adjaye Ltd should introduce the proposed policy. Support your answer
with relevant computations.
(15 marks)

Page 5 of 19
 QUESTION FIVE

a) The directors of Clear Tel Ltd, a private telecommunication company, are considering a
proposed resolution for converting the company to a public company and listing its equity
stock on the stock exchange. The directors expects that the stock market listing can
enhance Clear Tel’s ability to raise large amounts of capital from the public. However,
they fear that stock market inefficiencies could have a negative effect on the price of
Clear Tel’s equity stock.

Required:
Explain the THREE degrees of stock market efficiency, and how the price of Clear Tel is
expected to move in each case. (6 marks)

b) Restwell Ltd, a hotel leisure company, is currently considering taking over a smaller
private limited company, Staygood Ltd. The board of Restwell is in the process of making
a bid for Staygood, but first needs to place a value on the company. Restwell has gathered
the following data:

Year 2011 2012 2013 2014

GH¢ GH¢ GH¢ GH¢
Profit after tax 6,000,000 6,200,000 6,300,000 6,300,000

The company’s earnings yield is 12%.

Required:
i) As a Finance Manager, calculate the value of the company based on the present value of
expected earnings. (6 marks)
ii) Explain THREE problems associated with using P/E method for valuing firms.(3 marks)

(Total: 15 marks)

Page 6 of 19
SOLUTION TO QUESTIONS
QUESTION ONE

a)
 Changes in interest rates affect the public's demand for goods and services and,
thus, aggregate investment spending.
 A decrease in interest rates lowers the cost of borrowing, which encourages
businesses to increase investment spending.
 Lower interest rates also give banks more incentive to lend to businesses and
households, allowing them to spend more.
 Higher interest rates may make the corporate sector pessimistic about future
business prospects and confidence in the economy. This ay further reduce
investment in the economy.
 Higher interest rates will increase mortgage payments and will thus reduce the
amount of disposable income in the hands of home buyers for discretionary
spending.
 Higher interest rates encourage savers to save as more interest will be earned
from their savings or investments
(Any 4 points for 6 marks)
b)
i) The agency problem is a conflict of interest inherent in any relationship
where one party is expected to act in another's best interests. Within the
context of limited liability company, the agency problem usually refers to a
conflict of interest between a company's management and the company's
stockholders. The manager, acting as the agent for the shareholders, or
principals, is supposed to make decisions that will maximize shareholder
wealth even though it is in the manager’s best interest to maximize his own
wealth.
(2 marks)
ii) Causes of Agency Problem

 Managers prefer greater levels of consumption and less intensive work, as these
factors do not decrease their remuneration and the value of the company’s shares
that they own;
 Managers prefer less risky investments and lower financial leverage, because in
this way they may decrease the danger of bankruptcy, and avoid losses on their
managerial capital and portfolios;
 Managers prefer short-term investment horizon;
 Managers avoid problems stemming from reductions in employment levels,
which increase with the changes in control of a company.
 Managers also fear rocking the boat to deliver shareholder value and will rather
choose operating in their comfort zones.
(2 points for 2 marks)

Page 7 of 19
iii) Remedies of Agency Problem
 Managerial Compensation:
Managerial compensation refers to the incentive mechanism for the good
performance of the management. Their objectives are to attract and retain able
managers and to harmonize managerial actions with the interest of shareholders.
Several measures are used to evaluate managers' performance. Some of the most
common are sales, profit, current value of expected cash flows and value added.

 Shareholder control and interference

Shareholders can influence the company's management in two ways. Firstly,
they can influence management directly as to how the company should be
managed. Secondly, any shareholder can make a proposal which is voted on at
the annual general meeting (AGM).

 Threat of dismissal
In the past it seldom happened that a senior manager or chief executive officer
was dismissed by shareholders. The reason for this was possibly that the
ownership of a great number of companies was dispersed, as well as the fact that
the agency problem was only brought to the attention of shareholders (and
management) over the past two decades.

 Threat of take-overs
The threat of a take-over serves to monitor the actions of management. If the
actions or decisions of management decrease the future earnings or value of
shareholders, the share price usually decreases as well. In some instances, the
company can become a take-over target. If the management of such a company
is replaced, the move can benefit the shareholders. The threat of take-overs can
thus serves as an external control mechanism which ensures that the decisions
and actions of management maximize shareholders' wealth.
(4 points for 4 marks)
c) Reasons for Maximization of a company’s share price as preferred financial
objective
 It serves the interests of owners, (shareholders) as well as other stakeholders
in the firm; i.e. suppliers of loaned capital, employees, creditors and society.
 It is consistent with the objective of owners’ economic welfare.
 The objective of wealth maximization implies long-run survival and growth
of the firm.
 It takes into consideration the risk factor and the time value of money as the
current present value of any particular course of action is measured.
 The effect of dividend policy on market price of shares is also considered as
the decisions are taken to increase the market value of the shares.

Page 8 of 19
  The goal of wealth maximization leads towards maximizing stockholder’s
utility or value maximization of equity shareholders through increase in
stock price per share.
(4 points for 6 marks)
(Total: 20 marks)

EXAMINER’S COMMENTS
The question covered (a) to (c). The (a) part covered the effects of policy of high
interest rate on investment and expenditure, the question appeared a bit ambiguous
to some students and answers varied widely with students trying to answer
generally without going straight to the requirements. The performance was
generally average.

The (b) part appeared straight forward on agency problem, causes and remedies to
agency problem which was understood and well answered by the students
attracting good marks in the question.
The last part (c) was on why maximisation of company’s share price was preferred
to maximisation of sales. This attracted wide answers from students and overall
performance was average.

The overall performance on question one by students which was entirely essay and
attracted 20 marks was generally good with the (b) part helping students do better.

QUESTION TWO
a) (i) Cost of equity

Geometric average dividend growth rate = (21·8/19·38)0.25 – 1 = 0·0298 or 3%

Using the dividend growth model, ke = 0·03 + ((21·8 x 1·03)/2.5) = 0·03 + 8.9816=
9.0116 x 100% = 901.16%

Market values of equity and debt.

Market value of equity = Ve = 100m x 2·50 = GH¢250 million
Market value of bonds = Vd = 60m x (104/100) = GH¢62·4 million
Total market value = Ve + Vd = 250 + 62·4 = GH¢312·4 million
(4 marks)
(ii) WACC before new issue of bonds takes place
The current after-tax cost of debt is 7%

Page 9 of 19
WACC = ((ke x Ve) + (kd(1 – T) x Vd)/(Ve + Vd)) = ((901.16 x 250m) + (7 x
62·4m))/312·4m = 7.2256 x 100% =722.56%
The weighted average after-tax cost of capital before the new issue of bonds is
722.56%.
(3 marks)
WACC after new issue of bonds takes place

After-tax cost of debt of new bond issue

After-tax interest rate = 8 x (1 – 0·3) = 5·6% per year
Using interpolation:

Year Cash flow ¢ Discount at 5% PV

0 Market price -100 1.0 -100
1.-10 Interest 5.6 7.722 43.24
10 Redemption 105 0.614 64.47
7.71
Year Cash flow ¢ Discount at 6% PV
0 Market price -100 1.0 -100
1.-10 Interest 5.6 7.36 41.22
10 Redemption 105 0.558 58.59
- 0.19

After-tax cost of debt = 5 + [((6 – 5) x 7·71)/(7·71 + 0·19)] = 5 + 0·98 = 5·98% or 6%

WACC after new issue of bonds

The market value of the new issue of bonds is GH¢40 million
The total market value of Sevista Hotel increases to 312·4 + 40 = GH¢352·4 million
WACC = ((901.16 x 250m) + (7 x 62·4m) + (6 x 40))/352·4m = 641.5% or 642%
After the new issue of bonds, the weighted average after-tax cost of capital has
decreased from 722.56% to 641.5% because the proportion of debt finance, which has
a lower required rate of return than equity finance, has increased. Gearing on a
market value basis has increased from 20% (62·4/312·4) to 29% (102·4/352·4). The
WACC calculation assumes that the cost of equity has not changed, when in reality
the cost of equity might be expected to rise in response to the increase in financial
risk caused by the new issue of debt. The share price of the company has also been
assumed to be constant.
(3 marks)

b)
i) Theoretical ex-right price

GH¢
4 existing shares @ ¢3 12
1/5 Right share @ ¢2 2
14

Page 10 of 19
 14
Theoretical ex-right value of the shares = = ¢2.80
5
(4 marks)
ii) Value of a right = Theoretical ex-right prices – rights prices
= ¢2.80 - ¢2.0 = ¢0.80 (3 marks)

Value of an existing share required to purchase a right

¢0.80
= = ¢0.20
4
c)
(i) Sells the rights =
Pre-rights wealth = 1,000 shares @ ¢3.00 = ¢3,000

GH¢
Cash from selling rights = 1,000 x ¢0.20 = 200
Value of shares ex-rights = 1,000 x 2.80 = 2,800
Total wealth = 3,000
(3 marks)
(ii) Exercise half and sells the other half
Allowed 1,000/4 = 250 rights; purchases 125 @ ¢2.00; sells half and
gains 125 x ¢0.80.
Pre-rights wealth 1,000@¢3.00 = 3,000

After rights issue: = GH¢

Old shares 1,000@¢2.80 = 2,800
New shares 125 @ ¢2.80 = 350
Cash from sale 125 @¢0.80 = 100
Total wealth after right issue 3,000
(3 marks)

(iii) Does nothing GH¢

Pre-rights wealth after rights issue 3,000

After rights wealth GH¢

Old shares 1,000 @¢2.80 2,800
Total wealth 2,800
It is only if the shareholder does nothing that his wealth position will be
reduced. As long as all the rights are either sold or exercised his wealth
position will be unchanged. This is not surprising because the theoretical

Page 11 of 19
 ex-rights price has been calculated as a weighted average of the old price
and the price of the right.
(2 marks)

(Total: 25 marks)
EXAMINER’S COMMENTS
Question 2 was one of the longest and most comprehensive questions in the paper
which covered (a) to (c). The (a) part which covered the calculation of cost of equity
and weighted average cost of capital before and after the introduction of debt
(bonds) into the capital structure. This part created uncertainty among students as
the dividend per share provided in the question was almost 8 times the price of the
share. Dividend per share varied between 19.38 cedis per share to 21.8 cedis per
share for the listed years compared to the share price of 2.5 cedis per share thereby
producing unusual rates of return on equity and weighted average cost of capital.
This development confused students as most students left their answers
unconverted to percentages. The marking process took into consideration to ensure
fair assessment of students.
The (b) and (c) parts covered rights issue and determination of the value of rights
and the various scenarios and implications in the exercising or not exercising of the
rights on shareholders. This was a straight forward question which was well
answered and helped students perform well in this question. The question carried a
total of 25 marks.
The overall performance was fairly good.

QUESTION THREE
a) Calculation of Cost of Capital
(i) Cost of equity capital
D(1+g)
Ke = +g
Mv

Where D = Dividend proposed

g = Growth rate of dividend
Mv = Ex div market value of shares
¢0.20(1.15)+ g
= + 0.15
¢5.20−0.20

= 19.6%
(3 marks)

Page 12 of 19
(ii) Cost of preference shares
d 0.08
= = 16%
Mv 0.50
(2 marks)
(iii) Cost of redeemable debentures:
Year Value DF at PV DF at PV
12% 14%
0 Current (80) 1 (80) 1 (80)
1-20 Interest 10 7.47 74.7 6.62 66.2
20 Redemption value 110 0.10 11 0.07 7.70
NPV 5.70 (6.10)

Cost of redeemable debentures =

By interpolation:

5.70
12 + x 14 - 12
5.70+6.10
= 12.97%
(3 marks)
(iv) Calculation of weighted average cost of capital

Market value Cost of capital Weighted cost

GH¢ % GH¢
Ordinary shares 5,000 19.6 980
Preference shares 100 16 16
Debentures 1,600 12.97 207.56
6,700 1203.52
(2 marks)
1203.52
Weighted average cost of capital =
6,700
= 17.965% or 18%
Calculation of the net present value of project
GH¢
30,000
PV of annual net cash = 166,667
0.18
inflow
Less PV of initial outlay (150,000)
NPV 16,667
(3 marks)
Decision
Based on NPV criterion, the acceptance of the project is worthwhile.
(2 marks)

Page 13 of 19
 b)
i) Transaction exposure – This arises from the effect that exchange rate
fluctuations have on a company’s obligations to make or receive payments
denominated in foreign currency. This type of exposure is short-term to
medium-term in nature. Transaction exposure is driven by transactions which
have already been contracted for and hence they are of short term nature. For
example: if Company A, based in the US has already supplied goods worth
$100 Mio to another Company B in the UK and has agreed to receive the
payment in GBP, it has already undertaken transaction risk on cash flows.
(2.5 marks)

Economic (or operating) exposure – This is lesser-known than the previous

two, but is a significant risk nevertheless. It is caused by the effect of
unexpected currency fluctuations on a company’s future cash flows and
market value, and is long-term in nature. The impact can be substantial, as
unanticipated exchange rate changes can greatly affect a company’s
competitive position, even if it does not operate or sell overseas. For example,
a Ghanaian furniture manufacturer who only sells locally still has to contend
with imports from Asia and Europe, which may get cheaper and thus more
competitive if the dollar strengthens markedly.
(2.5 marks)

ii) Ways of Mitigating Transaction Exposure

The most common methods for hedging transaction exposures are −
 Forward Contracts − If a firm has to pay (receive) some fixed amount of foreign
currency in the future (a date), it can obtain a contract now that denotes a price
by which it can buy (sell) the foreign currency in the future (the date). This
removes the uncertainty of future home currency value of the liability (asset) into
a certain value.

 Futures Contracts − These are similar to forward contracts in function. Futures

contracts are usually exchange traded and they have standardized and limited
contract sizes, maturity dates, initial collateral, and several other features. In
general, it is not possible to exactly offset the position to fully eliminate the
exposure.

 Money Market Hedge − Also called as synthetic forward contract, this method
uses the fact that the forward price must be equal to the current spot exchange
rate multiplied by the ratio of the given currencies' riskless returns. It is also a
form of financing the foreign currency transaction. It converts the obligation to a
domestic-currency payable and removes all exchange risks.

 Options − A foreign currency option is a contract that has an upfront fee, and
offers the owner the right, but not an obligation, to trade currencies in a specified
quantity, price, and time period.

Page 14 of 19
 Risk Shifting − The most obvious way is to not have any exposure. By invoicing
all parts of the transactions in the home currency, the firm can avoid transaction
exposure completely. However, it is not possible in all cases.

 Currency risk sharing − The two parties can share the transaction risk. As the
short-term transaction exposure is nearly a zero sum game, one party loses and
the other party gains%

 Leading and Lagging − It involves playing with the time of the foreign currency
cash flows. When the foreign currency (in which the nominal contract is
denominated) is appreciating, pay off the liabilities early and collect the
receivables later. The first is known as leading and the latter is called lagging.

 Reinvoicing Centers − A reinvoicing center is a third-party corporate subsidiary

that uses to manage one location for all transaction exposure from intra-company
trade. In a reinvoicing center, the transactions are carried out in the domestic
currency, and hence, the reinvoicing center suffers from all the transaction
exposure.

 Netting
(Any 5 points for 5 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
The question consisted of two parts (a) and (b) with the (a) portions covering project
evaluation which was averagely answered attracting average marks. The
computation of costs of equity, preference shares, redeemable debentures and
overall weighted average cost of capital were well answered by most students but
some students struggled in the final computation of the NPV of the project. Few
students did very well.

The (b) part was essay type question was on transaction and economic exposures on
exchange risk and ways or strategies to mitigate transaction exposures. This was
straight forward and well answered by majority of students.
The question on overall basis attracted some good answers from students

Page 15 of 19
QUESTION FOUR

New level of sales will be 1,500,000 x 1.15 = ¢1,725,000

Variable costs are 80% x 75% = 60% of sales
Contribution from sales is therefore 40% of sales
(3 marks)

GH¢ GH¢
Proposed investment in debtors = 1,725,000 x 60/365 283,562
=
Current investment in debtors = 1,500,000 x 30/365 = 123,288
Increase in investment debtors 160,274

Increase in contribution = 15% x 1,500,000 x 40% = 90,000

New level of bad debts = 1,725,000 x 4% = 69,000
Current level of bad debts = 1,500,000 x 1% = 15,000
Increase in bad debts (54,000)
Additional financing costs = 160, 274 x 12% = (19,233)
Savings by introducing change in policy 16,767
(10 marks evenly spread using ticks)
Decision
The financing policy is financially acceptable, although the savings are not great.
(2 marks)
(Total: 15 marks)

EXAMINER’S COMMENTS
Question four which was on debtor’s management and policy on increasing
debtor days to boost sales. Students generally struggled to answer the question
well with most students struggling hard to work out some of the required
numbers to get some few marks. The question was poorly answered except the
few students who understood the question and scored the maximum marks. The
overall marks were 15 with majority getting below the average.

Page 16 of 19
QUESTION FIVE

a) The Three Basic Forms of the EMH

The efficient market hypothesis assumes that markets are efficient. However, the
efficient market hypothesis (EMH) can be categorized into three basic levels:

Weak-Form EMH
The weak-form EMH implies that the market is efficient, reflecting all market
information. This hypothesis assumes that the rates of return on the market
should be independent; past rates of return have no effect on future rates. In this
event that the stock market has weak-form efficiency, the price of Clear Tel will
move in line with historical changes.

Semi-Strong EMH
The semi-strong form EMH implies that the market is efficient, reflecting all
publicly available information. This hypothesis assumes that stocks adjust
quickly to absorb new information. The semi-strong form EMH also incorporates
the weak-form hypothesis. Given the assumption that stock prices reflect all new
available information and Clear Tel purchase stocks after this information is
released, Clear Tel cannot benefit over and above the market by trading on new
information.

Strong-Form EMH
The strong-form EMH implies that the market is efficient: it reflects all
information both public and private, building and incorporating the weak-form
EMH and the semi-strong form EMH. Given the assumption that stock prices
reflect all information (public as well as private) Clear Tel would not be able to
profit above the average investor even if he was given new information.

(2 marks for 3 points = 6 marks)

b) Restwell Ltd
i)
Year GH¢000 DF(12%) GH¢000
2011 6,000 0.893 5,358
2012 6,200 0.797 4,941.4
2013 6,300 0.712 4,485.6
2014 6,300 0.636 4,006.8
18,791.8
The value of the company based on the present value of expected earnings is
GH¢18,791,800.
(6 marks)

Page 17 of 19
 ii) Problems associated with P/E method for valuing firms

 Doesn’t account for growth- The price to earnings ratio doesn’t account for any
type of growth or the lack of growth. The fact that growth isn’t factored in means
that older more mature stocks are typically going to appear cheaper even if they
aren’t growing if you use the P/E ratio. For many investors growth is a variable
they do not want to exclude.

 Backward looking- The P/E ratio is actually a backward looking indicator if you
use the company’s most recent full year earnings number. A backward looking
number can be of very little help to the investor during a period where economic
conditions have changed significantly in a short period of time.

 Quality of earnings not considered- The last several months have been the
perfect example of how a company can really inflate their earnings to look better
than they really are. Many banks were able to do this for months, and because of
that investors that solely used the P/E ratio would have thought they were great
buys. In retrospect if the investor had been looking at other parts of the balance
sheet they may have seen inflated earnings as a real issue.

 The Price doesn’t consider debt- Companies with major debt issues are
obviously higher risk investments, but the P in the P/E ratio only considers the
equity price and does nothing with the debt that the business has to continue
with operations. As we have found out over time, excess debt can be a real
problem, and the market price of a stock isn’t always a good gauge of fair value.

 Uses profit which is not cash.

(Any 3 points for 3 marks)
(Total: 15 marks)

EXAMINER’S COMMENTS
This question was generally well answered by students that helped students
improve their total marks. It was a straight forward question with (a) part covering
degrees of stock market efficiency which was essay and generally well covered by
students.
The (b) part was a straight forward business valuation question where projected
earnings were to be discounted to present values over the given period to determine
the value of the company. Most students understood and answered the question
well attracting and earning the maximum marks
The problem part of the question was the used of historical years (2011 to 2014) as
the forecast or projected period which were historical relative to the current year of
the examination.
On Overall basis this is one of the questions that were well answered by students in
the paper.

Page 18 of 19
CONCLUSION
Remedies for observed weaknesses
 More preparation time by students before writing the paper.
 Minimum period should be allowed by ICA before a student sit for the exams
depending on the background of the student.
 More questions and answer bank and guide lines should be provided by the
Institute and other accredited tuition centres.
 ICA tuition and revision centres should incorporate exam comprehension and
answering techniques as part of their revision lectures and kits to better guide
students preparing to write the exams.
 Explore the possibility of implementing web based or electronic based tuition
and revision centres for students leaving outside the Accra area.
 Implementation of mock like exams by the accredited tuition centres to help
prepare the students to have the feel of the exams before the main exams and
feedback given at individual level on what went well and what didn’t go well
in the mock or pre exam test even if it is at an affordable fee for students.

Page 19 of 19
 MAY 2019 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

STANDARD OF PAPER
The standard and quality of the paper was generally normal consistent with
requirement and expectation. The distribution of the questions across the syllabus
was satisfactory with a balanced distribution between the quantitative and qualitative
or essay part of the syllabus with quantitative questions taking 57% and qualitative
taking the remaining 43%.The questions appeared easy to understand and apply
based on the standard expected of students at that level with no any major ambiguous
questions in the paper.

It was also generally observed that no sub-standard questions were set and quality of
questions considered good for that level. Mark allocations generally appeared fair and
satisfactory relative to the nature of questions depending on the level of difficulty and
extent of work expected of students.

The marking scheme was realigned in line with the questions on the question paper
and alternative solutions provided where necessary to accommodate varying
approaches to answering the questions.

PERFORMANCE OF CANDIDATES
The performance of the students was one of the worst in recent times with an average
pass rate of about 7% far lower than the remarkable improved performance in recent
times averaging over 25%. This requires vigorous and better preparation by the
students in generally and specifically on essay type questions and application
questions. With essay type questions taking 43% of the marks and a better preparation
on that side together with the quantitative side would have produced much better
performance the exams.
The possible reasons for the poor performance were as follows:
 Generally poor preparations by students for this sitting.
 Poor preparation on the basic theoretical concepts in Finance and poor time and
attention given to studying and understanding the essay area or non-quantitative
aspect of the course content.
 Complacency on the part of students possibly due to the recent improved
performance in the paper.
 Poor knowledge in answering applied questions.
 Student’s concentration on direct questions answering.

NOTABLE STRENTHGS AND PERFORMANCE OF STUDENTS

About 7% of students who did well exhibited the following strengths:
 Reading and understanding of the questions.
 Good preparations and understanding of the essay areas of the course content.
 Ability to understand and apply what was studied.

Page 1 of 22
 Better understanding of the requirements quantitative aspect of the questions.
 Ability to think broadly manifesting the level of thorough research in the study.

Observed reasons of the strengths:

The following were still considered valid for the strengths:
 Improvement in preparation for the paper
 Improvement in the Knowledge of how to answer questions
 Sufficient study of the entire syllabus and covering both quantitative and essay
areas of the syllabus
 Good background knowledge and experience in Finance
 Proper tuition, adequate study materials, research, reading and practice towards
the exams.

The strengths can be enhanced by:

 By continuous update of the study materials relevant to the syllabus.
 By focusing tuition on not only the quantitative aspect of the syllabus but the essay
type areas as well.
 Providing more digital channels of study.
 Teaching and coaching students how to think outside the box in difficult situations
and in questions that require general application of knowledge.

Observed weaknesses demonstrated by students

 Poor understanding of Finance principles
 Poor knowledge and preparation on non-quantitative aspect
 Failure to comprehend the requirements of the questions
 Continuous poor numbering of answers to questions making it difficult for
examiners
 Poor arrangement of answers to questions with answers to some questions
scattered across different pages haphazardly
 Poor handwriting and faded pens making reading and marking difficult for
examiners

Remedies for observed weaknesses

 Preparation of students by Tutors must go beyond the quantitative aspect a lone
and cover comprehensively the entire syllabus as over 40% of comes from the essay
type and concepts areas.
 Minimum period should be allowed by ICA before a student sit for the exams
depending on the background of the student.
 More practice on pass questions to broaden knowledge, experience and exposure
on handling or answering questions.
 Re-evaluation of the quality of the students and admission requirements for the
Institute.

Page 2 of 22
QUESTION ONE

a) Adenta Municipal Assembly (AdMA) has established an ultra-modern library and internet
facility for its inhabitants. It intends to subsidise the costs of using this facility for its
inhabitants. This facility is to be evaluated by the local assembly (AdMA) to assess amongst
other things, whether it is financially sound and offers value for money.

Required:
Suggest THREE (3) appropriate measures each of Financial, Economy, Efficiency and
Effectiveness that could be set for the facility based on targets. (12 marks)

b) The money market is the arena in which financial institutions make available to a broad
range of borrowers and investors the opportunity to buy and sell various forms of short-
term securities. The short-term debts and securities sold on the money markets which are
known as money market instruments have maturities ranging from one day to one year and
are extremely liquid.

Required:
Explain the following short term market instruments:
i) Bankers’ acceptance (2 marks)
ii) Commercial Paper (2 marks)
iii) Repurchase Agreement (Repo) (2 marks)
iv) Term deposit (2 marks)

(Total: 20 marks)

QUESTION TWO

a) M&E Ltd, recognised as the leader in steel manufacturing, has received an invitation to
supply steel for the construction of rail lines to connect the ECOWAS countries, starting
from Nigeria. The contract will be for 10 years, and management is considering appraising
the investment to enable them present their proposals for the contract. The following
information was extracted from the recently published accounts of M&E Ltd.

GH¢ ‘000
Equity Shares (1,000,000 shares) 70,000
15% Preference shares 50,000
10% (Bonds irredeemable) 30,000
Total 150,000

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance
the new project. The total amount would be raised through 10% Irredeemable bonds at the
current market price. The cost of Preference shares and Bonds will not change but equity
shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and
the Government of Ghana Bond rate is 20%. The current market price for Irredeemable
Bonds of GH¢1,000 nominal value is GH¢850.

Page 3 of 22
 M&E Ltd’s dividend policy is to pay constant dividend and this policy will not change into
the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free
Zones Company and therefore pays tax at a rate of 8%.

Required:
i) Calculate the current market capitalization of M&E Ltd. (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the
finance for the proposed project. (9 marks)

b) At a recent Board meeting, the Board Chair of Mempeasem Ltd suggested the need to
restructure the capital of their company. The Chair proposed shares repurchase as the option
to consider but majority of the Board members were hearing this term for the first time. As
the Finance Manager, you have been directed to help the Board members to understand this
option for decision making.

Required:
i) Explain the term share repurchase to a non-finance person. (1 mark)

ii) Identify FOUR (4) situations under which share repurchase will be useful for Mempeasem
Ltd. (5 marks)

c) If an existing public company chooses to issue shares, the financial market usually
interprets this as a sign that the company's share price is somewhat overvalued. To avoid
this negative impression, a company may choose to issue convertible bonds, which
bondholders are likely to convert to equity anyway should the company continue to do well.

Required:
Explain convertible debt and identify FOUR (4) attractions to a company of convertible
debt compared to a bank loan of a similar maturity as a source of finance. (5 marks)

(Total: 25 marks)

Page 4 of 22
QUESTION THREE

a) ASANTA Ghana Ltd is considering investing in the following projects which are
considered mutually exclusive:
PROJECT GO PROJECT COME
GH¢ GH¢
Annual cash inflows 1,000,000 2,000,000
Cost of Machine 2,500,000 6,000,000
Scrap value of Machine 250,000 1,000,000

Expected life of the Project 5 years 5 years

ASANTA Ghana Ltd uses the straight line method of depreciation. However, tax-allowable
depreciation is 30% on straight line basis. The cost of capital for the company is 20% per
annum.

Required:
i) Calculate the Accounting Rate of Return for each project. (4 marks)
ii) Calculate the Net Present Value (NPV) for each project. (4 marks)
iii) Compute the Internal Rate of Return (IRR) for each project. (4 marks)
iv) Compute the Payback period for each project. (3 marks)
(Note: In each of the above, advise the Company on which of the projects to implement
or undertake.)

b) Universal Plastics Ghana Ltd imported raw materials from U.S.A. and Europe for the
manufacture of plastic products. The company entered into option contracts with ZAA
Bank Ghana Ltd to hedge its six months’ currency risk or exposure.
The details of the option contracts are as follows:
Details Transaction Strike Spot Rate Option
Amount Price/ on premium
exchange Maturity paid to the
Rate Date Bank
OPTION A Bought Call US$10m USD/GH¢ USD/GH¢ GH¢ 1.4m
option to buy 4.7 4.5
USD against
GH¢
OPTION B Bought Call EUR 8m EUR/GH¢ EUR/GH¢ GH¢ 1.2m
option to buy 5.9 6.3
EURO against
GH¢

Required:
i) Calculate the profit or loss of OPTION A and advise Universal Plastics Ghana Ltd whether
to exercise or not. (4 marks)
ii) Calculate the profit or loss of OPTION B and advise Universal Plastics Ghana Ltd whether
to exercise or not. (4 marks)
iii) Calculate the overall profit or loss on the decision to hedge based on (i) and (ii) above.
(2 marks)

(Total: 25 marks)

Page 5 of 22
QUESTION FOUR

a) Lisa-Joys Company has annual credit sales of GH¢1,000,000. Credit customers take 45
days to pay. Bad debts are 2% of sales. The company finances its trade receivables with a
bank overdraft, on which interest is payable at an annual rate of 15%.

A factor has offered to take over administration of the receivables ledger and collections
for a fee of 2.5% of the credit sales. This will be a non-recourse factoring service. It has
also guaranteed to reduce the payment period to 30 days. It will provide finance for 80%
of the trade receivables, at an interest cost of 8% per year.

Lisa-Joys Company estimates that by using the factor, it will save administration costs of
GH¢8,000 per year.

Required
What would be the effect on annual profits if Lisa-Joys Company decides to use the factor’s
services? (Assume a 365-day year). (9 marks)

b) The need for working capital management vary from industry to industry, and they can
even vary among similar companies. This is due to several factors, including differences in
collection and payment policies, the timing of asset purchases, the likelihood of a company
writing off some of its past-due accounts receivable, and in some instances, capital-raising
efforts a company is undertaking. Proper management of working capital is essential to a
company’s fundamental financial health and operational success as a business.

Required:
Explain FOUR (4) advantages a company may derive from proper working capital
management. (6 marks)

(Total: 15 marks)

Page 6 of 22
QUESTION FIVE

a) Anape Ltd is considering issuing a new 10-year bond in the domestic market. The interest
rate on the bond is 20%. Interest will be paid semi-annually. The directors are considering
the appropriate price at which the new bonds should be sold. The market required return is
25%.

Required:
i) Compute the price investors would be willing to pay for each GH¢100 face value bond.
(5 marks)
ii) Explain how changes in average interest rate affect the value of bonds. (4 marks)

b) The dividend growth model also has its fair share of criticism. While some have hailed it
as being indisputable and being not subjective, recent academicians and practitioners have
come up with arguments that make you believe the exact opposite. Recent studies have
unearthed some glaring flaws in what was considered to be a perfect valuation model.

Required:
Identify and explain THREE (3) weaknesses of the dividend growth model as a way of
valuing a company with shares. (6 marks)

(Total: 15 marks)

Page 7 of 22
SOLUTIONS TO QUESTIONS

QUESTION ONE

a) Financial measures:
• Proportion of overall funds spent on administration costs
• Ability to stay within budget/break even
• Revenue targets met.
(3 points for 3 marks)
Economy targets:
• Costs of purchasing books of suitable quality
• Costs of negotiating for and purchasing equipment.
• Negotiation of bulk discounts
• Pay rates for staff of appropriate levels of qualification.
(3 points for 3 marks)
Efficiency targets:
• Levels of wastage of outdated books
• Staff utilisation
• Equipment life.
(3 points for 3 marks)
Effectiveness targets:
• Numbers using the library
• Customer satisfaction ratings
• Quality of books and speed of internet served
(3 points for 3 marks)

b)
i) Bankers' Acceptances
A banker's acceptance is an instruments produced by a nonfinancial corporation
but in the name of a bank. It is document indicating that such-and-such bank shall
pay the face amount of the instrument at some future time. The bank accepts this
instrument, in effect acting as a guarantor. To be sure the bank does so because it
considers the writer to be credit-worthy. Bankers' acceptances are generally used
to finance foreign trade, although they also arise when companies purchase goods
on credit or need to finance inventory. The maturity of acceptances ranges from
one to six months.

ii) Commercial Paper

Commercial paper refers to unsecured short-term promissory notes issued by
financial and nonfinancial corporations. Commercial paper has maturities of up to
270 days (the maximum allowed without SEC registration requirement). Dollar
volume for commercial paper exceeds the amount of any money market
instrument other than T-bills. It is typically issued by large, credit-worthy
corporations with unused lines of bank credit and therefore carries low default
risk.

Page 8 of 22
 Unlike some other types of money-market instruments, in which banks act as
intermediaries between buyers and sellers, commercial paper is issued directly by
well-established companies, as well as by financial institutions. Banks may act as
agents in the transaction, but they assume no principal position and are in no way
obligated with respect to repayment of the commercial paper. Companies may also
sell commercial paper through dealers who charge a fee and arrange for the
transfer of the funds from the lender to the borrower.

iii) Repos-Repurchase Agreements

Repurchase agreements—also known as repos or buybacks—are Treasury
securities that are purchased from a dealer with the agreement that they will be
sold back at a future date for a higher price. These agreements are the most liquid
of all money market investments, ranging from 24 hours to several months. In fact,
they are very similar to bank deposit accounts, and many corporations arrange for
their banks to transfer excess cash to such funds automatically.

iv) Term deposit

A term deposit is a cash investment held at a financial institution. Your money is
invested for an agreed rate of interest over a fixed amount of time, or term. Term
deposits can be invested into a bank, building society or credit union. When the
money is deposited, the customer understands that the money is there for the pre-
determined period which usually ranges from 1 month to 5 years and the interest
rate is guaranteed not to change for that nominated period of time. Typically, the
money can only be withdrawn at the end of the period – or earlier with a penalty
attached.

Term deposits are popular with investors who prefer capital security and a set
return as opposed to the fluctuations of, say, the share market. Many investors also
use term deposits as a part of their investment mix.
(4 points well explained @ 2 marks each = 8 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
The question covered (a) and (b) which carried 20 marks. The (a) part covering the
concepts of Financial, Economy, Efficiency and Effectiveness as they apply to Adentan
Municipal Assembly on a library project on value for money analysis. This was an
application of the 3Es but the students generally struggled to apply these principles
to the question which attracted low to medium marks.

The (b) part covered basic Finance concepts of Bankers Acceptance, Commercial
Paper, Repurchase Agreement and term deposit which were well answered by
students.
Overall this was the best answered question in the paper. Almost 30 percent of all
those who answered this question got a pass or better for that question.

Page 9 of 22
QUESTION TWO

a)
i) M&E Market capitalization

Workings
Market price per equity
𝑟 = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓);
𝑟𝑚 − 𝑟𝑓 = 6.25%; 𝛽 = 0.8; 𝑎𝑛𝑑 𝑟𝑓 = 20%
𝑟 = 20 + (0.8 × 6.25) = 25% (2 marks)

Dividend paid is GH¢ 20 per share

20
𝑝= = 𝐺𝐻𝑆 80 (1 mark)
0.25

Capitalisation GH¢ ‘000

Equity Shares (1,000,000) (1,000,000x80) 80,000 0.5 mark
15% Preference shares 50,000 0.5 mark
10% Bonds – Irredeemable 850
(1,000 × 30,000) 25,500 1 mark
Total 155,500
(2 marks)

ii) WACC = 16.89%

Capital ‘000 Cost Amount’000
Equity Shares 80,000 20.00% 16,000.00 (2 marks)
15% Preference shares 50,000 15.00% 7,500.00 (2 marks)
10% Bonds – Irredeemable 25,500 10.82% 2,759.10 (2 marks)
Total 155,500 16.89% 26,259.10 (2 marks)

0.1×1000
Cost of bonds is × (1 − 0.08) = 10.82% (1 mark)
850

b)
i) Share repurchase
Share repurchase is the process where a company buys back its own share from
investors or from the stock market. (1 mark)

ii) Companies may purchase their own shares for the following reasons
• Discourage unfriendly takeover
• Shares repurchased can be used to enhance shareholder value or discourage an
unfriendly takeover.
• Acquire another business
• Companies can repurchase their own shares to be used for acquisition of another
company.

Page 10 of 22
• For employees share options
Where shares are used as part of employee salary package, a company can
purchase its own shares for that purpose.
• For retirement
Companies can buy their own shares and retire the shares.
• Redistribution of excess cash
Companies with excess cash as a result of excessive retained earnings can
redistribute the excess cash to shareholders through purchase of own shares.
• As part of agreement with investors (Share repurchase agreement)
Where there is an agreement with an investor that the company will buy its shares
from the investor after a given period, the company will have to comply with this
agreement by purchasing its own shares from the investor. This is also referred to
as share repurchase agreement.
(1 mark for any 1 point up to a maximum of 5 marks)

c) Convertible loan notes are bonds that, at the option of the holder, can be converted
into ordinary shares. If not converted, it will be redeemed like ordinary or straight
debt on maturity. (1 mark)

Convertible debt has a number of attractions compared with a bank loan of

similar maturity, as follows:
• Self-liquidating
Provided that the conversion terms are pitched correctly and expected share price
growth occurs, conversion will be an attractive choice for bond holders as it offers
more wealth than redemption. This occurs when the conversion value is greater
than the redemption value, or when the conversion value is greater than the floor
value on the conversion date. If the debt is converted into ordinary shares, it will
not need to be redeemed. A bank loan of a similar maturity will need to have all of
the capital repaid.

• Lower interest rate

It will be lower than the interest rate on ordinary debt such as a bank loan because
of the value of the option to convert. The returns on fixed-interest debt will not
increase with corporate profitability, so debt providers will have a limited share of
the benefits from the investment of the funds they have provided. When debt has
been converted, however, bond holders become shareholders and will potentially
have unlimited returns, or at least returns that are higher than the returns on debt
finance.

• Increase in debt capacity on conversion

Gearing increases when convertible debt is issued, but if conversion occurs, the
gearing will fall not only because the debt has been removed, but will fall even
further because equity has replaced the debt. The debt capacity of the company
will therefore be enhanced by conversion, compared to redemption of a bank loan
of a similar maturity.

Page 11 of 22
• More attractive than ordinary debt
It may be possible to issue convertible debt even when ordinary debt such as a
bank loan is not attractive to lenders, since the option to convert offers a little extra
that ordinary debt does not. This is the option to convert in the future, which can
be attractive to optimists, even when the short- and medium-term economic
outlook may be poor.
 Stable and long term funding source
 Converted at a premium usually
(4 points well explained for 4 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
Question 2 was one of the most comprehensive question covering (a) to (c) with a total
of 25 marks.

The (a) portion of the question which covered calculation of market capitalisation and
determination of weighted average cost of Capital was the worst answered part of the
questions as students struggled to calculate the price of the share and the cost of the
bonds which were very key in answering the question which 14 marks out of the total
25 marks. This negatively impacted the overall score of the candidates in the question.
The (b) portion which was on share repurchase and situations under which that will
be useful had good performance generally from students but carried only a total of 5
marks.

The (c) part which covered convertible debt and attraction to issuing convertible debt
compared to bank loan also had good responses from the students but carried only 5
marks.

Overall question 2 was the second worst answered in the paper driven mainly by the
(a) part which carried almost 60% of the marks in the question. Only about 4% of the
students who answered this question got a pass mark.

Page 12 of 22
QUESTION THREE

a)
i) PROJECT GO PROJECT COME
Accounting Profit: GH¢ GH¢
Cash inflow 1,000,000 2,000,000
Depreciation:
(2,500,000 - 250,000)/5 years (450,000)
(6,000,000 – 1,000,000)/ 5years ____________ (1,000,000)
Annual Profit 550,000 1,000,000

Average Book Value:

PROJECT GO (2,500,000 + 250,000)/2 = 1,375,000)
PROJECT COME (6,000,000 + 1,000,000)/2 = 3,500,000)

Accounting Rate of Return = 550,000 * 100 1,000,000 *100

1,375,000 3,500,000
= 40% 29%
Alternatively: (Using cost of Machine or investment)

550,000 x 100 1,000,000 x 100

2,500,000 6,000,000
= 22% = 17%
Decision:
PROJECT GO gives the highest Rate of return and should be selected
(4 marks)

ii) Net Present Value (NPV) method

NPV @ 20%
PROJECT GO PROJECT COME
GH¢ GH¢
Year 0 Cost (2,500,000) (6,000,000)
Year 1 – 5 cash flows:
Annuity factor (2.991)
1,000,000 x 2.991 = 2,991,000
2,000,000 x 2.991 = 5,982,000

Year 5 Scrap value:

250,000 x 0.402 = 100,500
1,000,000 x 0.402 = __________ 402,000
NPV 591,500 384,000

Decision
Both projects produced positive NPVs but project GO has the highest NPV and
should be selected since both projects are mutually exclusive.
(4 marks)

Page 13 of 22
iii) Internal Rate of Returns (IRR)
@ 20% NPV was at positive.
Using 40%
PROJECT GO PROJECT COME
GH¢ GH¢
Year 0 Cost (2,500,000) (6,000,000)

Year 1 – 5 cash flows:

Annuity factor (2.035)
1,000,000 x 2.035 = 2,035,000
2,000,000 x 2.035 = 4,070,000

Year 5 Scrap value:

250,000 x 0.186 = 46,500

1,000,000 x 0.186 = ___________ 186,000

NPV (418,500) (1,744,000)

IRR

PROJECT GO = 20% +591,500 X ( 40% -20%)

(591,500+418,500)
= 20% + (591,500/1,010,000) X (20%)
= 20% + (0.5856) X 20%
= 20% + 11.71%
= 31.71% 0R 32%

PROJECT COME = 20%+ 382,000 X (40% -20%)

(384,000+1,744.000)
= 20% + (382,000/2,128,000) X (20%)
= 20% + (0.1795) X 20%
= 20% + 3.59%
= 23.6% 0R 24%

Decision
Both projects give IRR above the 20% cost of Capital, Project GO gives the highest
32% and should be taken since the two projects are mutually exclusive
(4 marks)

Page 14 of 22
iv) Payback Period
PROJECT GO PROJECT COME
GH¢ GH¢
Cost of Machine 2,500,000 6,000,000
---------------- ----------------
Cash inflow 1,000,000 2,000,000

Payback period = 2.5 years 3 years

Decision:
Project GO gives the lowest payback period and should be selected. (3 marks)

b)
i) Profit/Loss of exercising : (OPTION A)
Cost of exercising
GH¢
$10m @ 4.7 = 47,000,000
Premium paid = 1,400,000
--------------
TOTAL 48,400,000
--------------

Cost of not Exercising and buying from the spot market

GH¢
$10m @ 4.5 = 45,000,000
--------------
TOTAL 45,000,000
---------------

Difference (LOSS): 48,400,000 - 45,000,000 = 3,400,000

 By exercising the total cost is GHS 48,400,000 (inclusive of premium paid)
 By Not exercising and buying from the spot market the total cost is GHS
45,000,000
 The LOSS will be 3,400,000 for exercising option A.

Decision:
Universal Plastics should not exercise the option but buy from the spot market
That will be cheaper not withstanding option premium already paid for the he

Alternatively:
The option is out of the money since the spot rate was lower than the option
rate and should not be exercised. The maximum loss is the option premium of
1,400,000 cedis. (4 marks)

Page 15 of 22
ii) Profit / Loss of exercising (OPTION B):
Cost of exercising
GH¢
EUR 8m @ 5.9 = 47,200,000
Option premium paid = 1,200,000
Total 48,400,000

Cost of not exercising by buying from the spot market:

GH¢
EUR 8m@ 6.3 = 50,400,000
Option premium paid = 1,200,000
Total 51,600,000

Profit/Gain for exercising = Rate Differentials less premium paid in buying protection
= 51,600,000 – 48,400,000 = 3,200,000 -1,200,000
= 2,000,000

OR 50,400,000 – 47,200,000 = 3,200,000 – 1,200,000

= 2,000,000

OR (6.3 -5.9) X EUR 8m = 3,200,000 – 1,200,000

= 2,000,000
Decision:
Universal Plastics should exercise option B as it will Profit or gain
= GHS 2,000,000
(4 marks)

iii) The overall effect as follows:

GH¢
OPTION A: LOSS (If exercised) = ( 3,400,000)
OPTION B Profit or gain for Exercising = 2,000,000
--------------
Overall Net profit (LOSS)for the hedge (1, 400,000)
=======

Alternatively
OPTION A: Option premium loss (Not exercised) = (1,400,000)
OPTION B Profit or gain for Exercising = 2,000,000
--------------
Overall Net profit (LOSS) for the hedge 600,000
=======
(2 marks)

(Total: 25 marks)

Page 16 of 22
EXAMINER’S COMMENTS
This question had (a) and (b) parts and carried a total of 25 marks.

The (a) portion tested students’ knowledge on Accounting Rate of Return, Net Present
Value, Internal Rate of Return and Payback period and carried a total marks 16 marks.
This part had good answers from students and contributed to pass rates of the
students who passed. Students generally did well but some students failed to use the
annuity factor but went through a detailed approach.

The (b) portion which was an application side of using options to hedge a currency
risk and making decision to exercise or not to exercise on the due date. Students
generally did well in computing the market values and hedge values to make the
decision which were generally ok but some of the decisions from the students to
exercise or not exercise were at variance with their calculation but on overall basis
over 13% of student who answered this question passed and good number slightly
below the pass mark

Page 17 of 22
QUESTION FOUR

a) GH¢
Current average trade receivables 45/365 × GH¢1 million 123,288
Average receivables with the factor 30/365 × GH¢1 million 82,192

It is assumed that if the factor’s services are used, 80% will be financed by the factor
at 8% and the remaining 20% will be financed by bank overdraft at 15%.

Annual interest costs GH¢

Current situation GH¢123,288 × 15% 18,493
With the factor (80% × GH¢82,192 × 8%) + (20% × GH¢82,192 × 15%) (7,726)
Saving in annual interest costs 10,767

Summary of comparative costs GH¢

Saving in annual interest costs 10,767
Annual saving in bad debts (2% of GH¢1 million) 20,000
Annual saving in administration costs 8,000
38,767

Annual costs of factor’s services (2.5% of GH¢1 million) (25,000)

Net increase in profit by using the factor 13,767
(9 marks evenly spread using ticks)
Alternatively:

Before Factor Service:

Bad Debts (2% x 1,000,000) = (20,000)
Admin Cost = ( 8,000 )
Debtors Financing:
45/365 x 1,000,000 = 123,287 x 15% = (18,493)
------------
(46,493)
--------------
After Factor Service:
Factor Fee ( 2.5% x 1,000,000) = (25,000)
Debtor Financing:
30/365 x 1,000,000 =( 82,192
Factor ( 80% x 82,192) x 8% = 5,260

Company ( 20% x 82,192) x15% = 2,466

---------- (7,726)
------------
Total Cost taking factor (32,726)
------------
Difference = (46,493- 32,726) = 13,767
=======

Page 18 of 22
b) Working capital is a vital part of a business and can provide the following
advantages to a business:
 Higher Return on Capital
Firms with lower working capital will post a higher return on capital. Therefore,
shareholders will benefit from a higher return for every dollar invested in the
business.

 Improved Credit Profile and Solvency

The ability to meet short-term obligations is a pre-requisite to long-term solvency.
And it is often a good indication of counterparty’s credit risk. Adequate working
capital management will allow a business to pay on time its short-term obligations.
This could include payment for a purchase of raw materials, payment of salaries,
and other operating expenses.

 Higher Profitability
The management of account payables and receivables is an important driver of
small businesses’ profitability.

 Higher Liquidity
A large amount of cash can be tied up in working capital, so a company managing
it efficiently could benefit from additional liquidity and be less dependent on
external financing. This is especially important for smaller businesses as they
typically have limited access to external funding sources. Also, small businesses
often pay their bills in cash from earnings so efficient working capital management
will allow a business to better allocate its resources and improve its cash
management.

 Increased Business Value

Firms with more efficient working capital management will generate more free
cash flows which will result in higher business valuation and enterprise value.

 Favourable Financing Conditions

A firm with a good relationship with its trade partners and paying its suppliers on
time will benefit from favourable financing terms such as discount payments from
its suppliers and banking partners.

 Uninterrupted Production
A firm paying its suppliers on time will also benefit from a regular flow of raw
materials, ensuring that the production remains uninterrupted and clients receive
their goods on time.

 Ability to face shocks and peak demand

Efficient working capital management will help a firm to survive through a crisis
or ramp up production in case of an unexpectedly large order.

Page 19 of 22
 Competitive Advantage
Firms with an efficient supply chain will often be able to sell their products at a
discount versus similar firms with inefficient sourcing.
(4 points @ 1.5 marks each = 6 marks)
(Total: 15 marks)

EXAMINER’S COMMENTS
Question four was a 15-mark question and was on working capital management
combining both calculation for decision making and essay type. The (a) portion was
on the use of a factor and the impact of that in the results of debts management which
was well answered but some students did well in the calculation of the various
numbers but had challenges in the presentation of the numbers in a consolidated
format for clear difference in the status co and using a factor.

The (b) portion which was on advantages of proper working capital management
received good and out of box thinking answers from the students.

Overall, this was the second best answered question even though it was carrying 15
marks with over 23% pass rate

Page 20 of 22
 QUESTION FIVE

a)
i) Price investors would be willing to pay
Face value= GH¢ 100
Coupon rate = 20%, paid semi-annually
Required return= 25%

1
1− RV
(1 + k d )n
V0 = I ( )+
kd (1 + k d )n

I= 0.2 * GH¢ 100 = GH¢ 20 (0.5 marks)

RV= Face value = GH¢ 100 (0.5 marks)

1
1−
0.25 2∗10
(1 + ( 2 )) 100
V0 = 20/2 +
0.25/2 0.25
(1 + ( 2 ))2∗10
( )

= 72.41 + 9.48
=81.89
(4 marks)

ii) There is an inverse relationship between interest rates and price of bonds. As
interest rates rise, bond prices drop. Conversely, as interest rates decline, bond
prices rise. Interest rate movements reflect the value of money or safety of
investment at a given time. The movement of interest rates affects the price of
bonds because the coupon rate of interest, the money the issuer pays semi-
annually to the owners of its bonds, remains fixed until the bond matures and
pays the GH¢1,000 principal. The fixed semi-annual interest payments and the
fixed repayment of principal at maturity are why bonds are called fixed income
investments.
(4 marks)

b) The dividend growth model (DGM) is used widely in valuing ordinary shares and
hence in valuing companies, but there are a number of weaknesses associated with
its use.

 The future dividend growth rate

The DGM is based on the assumption that the future dividend growth rate is
constant, but experience shows that a constant dividend growth rate is, in reality,
very rare. This may be seen as less of a problem if the future dividend growth rate
is regarded as an average growth rate. Estimating the future dividend growth rate
is very difficult in practice and the DGM is very sensitive to small changes in this

Page 21 of 22
 key variable. It is common practice to estimate the future dividend growth rate by
calculating the historical dividend growth, but the assumption that the future will
reflect the past is an easy one to challenge.

 The cost of equity

The DGM assumes that the future cost of equity is constant, when in reality it
changes quite frequently. The cost of equity can be calculated using the capital
asset pricing model, but this model usually employs historical information, which
may not reflect accurately expectations about the future.

 Zero dividends
It is sometimes claimed that the DGM cannot be used when no dividends are paid,
but this depends on whether dividends are expected in the future. If dividends are
forecast to be paid from a future date, the dividend growth model can be applied
at that point to calculate a share price, which can then be discounted to give the
current ex dividend share price. Only in the case where no dividends are paid and
no dividends are expected to be paid will the DGM have no application.
(3 points well explained @ 2 marks each = 6 marks)
(Total: 15 marks)

EXAMINER’S COMMENTS
Question 5 was worst answered in the paper. The (a) part of the question was on the
determination of the price of a bond and how average interest rates affects the value
of the bond. Even though the question appeared straight and required straight
calculation students found it difficult to comprehend and also lacked knowledge and
appreciation of the relationship between interest rate and the value of bonds.

The (b) portion was on weaknesses of the dividend growth model as a method of
valuing a company. This was poorly answered and appeared as an unexpected or
strange question to students based on their responses and carried 6 marks.
Overall the pass rate in this question was about 3%

On overall, general performance in the paper was poor and driven to a larger extent
by Questions 2 and 5 totalling 40 marks which had poor pass rates.

Page 22 of 22
 MAY 2020 PROFESSIONAL EXAMINATION
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

STANDARD OF THE PAPER

The quality and standard of the paper was generally good and covered both
quantitative and theory or essay related questions to test candidates’ knowledge in
both areas.

The distribution of the questions was in line with the syllabus in terms of coverage but
shifted more towards quantitative related questions. The quantitative aspect covered
78% whilst the theory or essay aspect covered only 22%. This was a shift from the
last two sittings where it was quantitative (64%) and theory (36%) for November 2019
and quantitative (57%) and theory (43%) for May 2019 paper. The trend will have to
be relooked at in subsequent papers where at least the essay or theory should cover
not less than 30%.

The questions were generally clear and easy to understand and apply by candidates
who prepared well and had knowledge of the subject but posed difficulties to ill
prepared candidates. No sub-standard questions were noted in the paper except over
concentrated question in one area of the syllabus and the quality of questions were
considered appropriate for this level.

Marks allocations were also considered good with exception of low number of theory
questions and marks.

In terms of marking scheme, it was reviewed and aligned to the question paper.
Alternative solutions were also provided where necessary to accommodate various
approaches to answering the questions.

PERFORMANCE OF CANDIDATES
DETAILS NUMBER OF CANDIDATES PERCENTAGE (%)
Pass 69 13
Fail 473 87
Total 542 100

The performance of the candidates showed a deterioration with the overall pass rate
dropping to 13% compared to the 29% in the previous sitting but better than the 7%
attained in the May 2019 paper. This could partially be attributed to the negative
impact of the COVID 19 on candidate’s preparation and nervousness towards safety.

The possible reasons for some poor performance were as follows:

 Poor preparation by some candidates that could be partially due to COVID 19
constraints
 Poor questions answering and time management skills

Page 1 of 21
 Poor, labelling of questions, handwriting and use of faded pens still featured
notwithstanding the consistent highlighting of this problem
 Weak knowledge in answering the main quantitative questions carrying high
marks.
 Weak grasp of the quantitative knowledge on Business valuation and operating
leverage and financial leverage
 Complacency on the part of some candidates due to the good performance at the
last examinations

NOTABLE STRENTHGS AND PERFORMANCE OF CANDIDATES

The 13% of the candidates who passed the paper and those who did well in some
questions exhibited the following strengths:
 Noticeable improvement in the understanding of the requirements of the questions
 Better appreciation and preparation in the quantitative areas of the syllabus which
covered over 70% of the questions
 Improvement in understanding and application of what was studied showed up
again
 Growth in knowledge and understanding of how to handle applied questions in
the exams

Observed reasons of the strengths:

 Enhancement in the quality of digital access to study material and knowledge in
the subject area
 Improvement in the usage of non-contact quality study materials through the use
of technology during the challenging COVID-19 period
 Better preparation, understanding and practice of more quantitative related
questions.

The strengths can be enhanced by;

 Review of the study materials relevant to the new syllabus
 Further improvement on the contactless digital channels of study
 Knowledge and experience sharing by good performing past candidates

Observed weaknesses demonstrated by candidates:

 Poor grasp of quantitative aspect of the new syllabus by some candidates
 Still continuous poor numbering of answers to questions making it difficult for
examiners
 Poor handwriting and faded pens making reading and marking difficult still
prevalent

Remedies for observed weaknesses:

 Continuous Performance feedback sessions by the Institute or through the various
tuition centres and digital channels
 More hands on and practice on exercises and past questions,
 Use of modern tuition technology to reach out to majority of candidates including
those outside Accra

Page 2 of 21
 One on one or written feedback to the very poor performing candidates to create
alertness and seriousness in candidates

Summary of Performance on Question Basis

QUESTION PASS % FAIL % TOTAL %
Question 1 56 10 485 90 541 100
Question 2 27 5 514 95 541 100
Question 3 94 17 447 83 541 100
Question 4 122 23 419 77 541 100
Question 5 356 66 185 34 541 100
Overall pass 69 13 472 87 541 100

Page 3 of 21
QUESTION ONE

a) K-Force Ltd, a newly established security company, has constituted its first board of
directors. The directors are expected, among others, to take financial decisions in the areas
of investment, financing, and dividend payment. A consultancy firm has been engaged to
run an orientation program for the directors in the coming week.

You work with the consultancy firm that has been engaged to run the orientation program
for the new directors. You have been asked by your boss to prepare briefing notes on the
specific roles the directors are expected to play in the three fundamental decision areas and
the constraints that government policies might impose on them.

Required:
Prepare a briefing note on the nature of the three fundamental decision areas. Specifically,
the briefing notes should cover the objective of each class of decision; TWO (2) specific
decisions the directors are expected to take in each class of financial decisions; and TWO
(2) factors in the external environment they should consider when making financial
decisions.
(10 marks)

b) Firm A and Firm B are both subsidiary companies of Groupe Trojan Electronics. The
directors of Groupe Trojan Electronics are reviewing the capital structure of the two
subsidiary companies. You have been engaged to advise the directors on the appropriate
capital structure for the subsidiaries.

You have obtained extracts from the financial results of the two companies for the past
financial year and projection of the annual results for the current year, which is in its first
quarter.

Projected Results – 2019 Historical Results – 2018

Firm A Firm B Firm A Firm B
Sales units (millions) 7.2 3.6 12 6
Price per unit (GH¢) 40 62 40 62
GH¢'million GH¢'million GH¢'million GH¢'million
Sales revenue 288.00 223.20 480.00 372.00
Variable costs 172.80 44.64 288.00 74.40
Fixed costs 40.00 128.00 40.00 128.00
Total operating costs 212.80 172.64 328.00 202.40
Operating profits 75.20 50.56 152.00 169.60
Interest expense 35.00 110.00 35.00 110.00
Profit before tax 40.20 (59.44) 117.00 59.60
Tax 10.05 (14.86) 29.25 14.90
Profit after tax 30.15 (44.58) 87.75 44.70

Required:
i) Compute the degree of operating leverage for each of the two companies. Based on the
degree of operating leverage you obtain, advise the directors on the relative level of
business risk associated with the two subsidiaries and the implication of that for capital
structure design. (5 marks)

Page 4 of 21
ii) Compute the degree of financial leverage for each of the two companies. Based on the
degree of financial leverage you obtain, advise the directors on the relative level of financial
risk associated with the two subsidiaries and the implication of that for capital structure
design. (5 marks)

(Total: 20 marks)

QUESTION TWO

Restwell Ltd (Restwell), a hotel and leisure company is currently considering taking over
a smaller private limited liability company, Staygood Ltd (Staygood). The board of
Restwell is in the process of making a bid for Staygood but first needs to place a value on
the company. Restwell has gathered the following data:

Restwell
Weighted average cost of capital 12%
P/E ratio 12
Shareholders’ required rate of return 15%

Staygood
Current dividend payment (GH¢) 0.27
Past five years’ dividend payments (GH¢) 0.15,0.17,0.18, 0.21,0.23
Current EPS 0.37
Number of ordinary shares issued 5 million

The required rate of return of the shareholders of Staygood is 20% higher than that of
Restwell due to the higher level of risk associated with Staygood. Restwell estimates that
cash flows at the end of the first year will be GH¢2.5 million and these will grow at an
annual rate of 5%. Restwell also expects to raise GH¢5 million in two years’ time by selling
off hotels of Staygood that are surplus to its needs.

Required:
Estimate values for Staygood using the following valuation methods:
i) Price/earnings ratio valuation. (6 marks)
ii) Gordon growth model. (8 marks)
iii) Discounted cash flow valuation. (6 marks)

(Total: 20 marks)

Page 5 of 21
QUESTION THREE

a) Odapagyan Foods Ltd is borrowing GH¢500,000 to finance a project involving an

expansion of its existing factory. It has obtained an offer from Sika Bank. The terms of the
loan facility are as follows:

Annual interest rate: 22%

Duration: 2 years
Interest method: compound interest with quarterly compounding
Payment plan: equal instalments at the end of each quarter

Required:
i) Compute the quarterly instalment. (3 marks)

ii) Prepare a loan amortisation schedule to show the periodic interest charges, instalment
payments, principal payments, and balance of the loan at the end of each quarter. (7 marks)

b) Asanka Ghana Ltd is a medium size business in Ghana that is currently borrowing
GH¢1,000,000 from North East Bank at a floating or variable interest rate basis at Ghana
Reference Rate (GRR) plus 3% margin which is market determined on monthly basis. This
makes their monthly interest payment volatile depending on where GRR is at the end of
the month. They are rather interested in fixed interest payment at the end of the month to
manage this volatility.

OTI Bank Ghana Ltd has agreed to do an Interest rate Swap with Asanka where OTI Bank
Ghana Ltd pays the variable rate to Asanka but Asanka pays them a fixed rate of 21% per
annum paid monthly.

The table below shows the GRR for the last 6 months:
Month GRR Interest Fixed Interest Net
(A) (B) (Variable) Rate (Fixed) Settlement
(C) (D) (E) (F)
1 16% 21%
2 18% 21%
3 20% 21%
4 19% 21%
5 18% 21%
6 17% 21%

Required:
i) Calculate the variable interest, fixed interest and net settlement under columns (C), (E) and
(F) in the table above. (8 marks)

ii) Will you describe this strategy as an interest rate hedge? Explain. (2 marks)

(Total: 20 marks)

Page 6 of 21
QUESTION FOUR

Sabir Company is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing GH¢2,000,000. The equipment
will be used to produce a range of products for which the following estimates have been
made.
Year 1 2 3 4
Average unit sales price GH¢73.55 GH¢76.03 GH¢76.68 GH¢81.86
Average unit variable cost GH¢50.00 GH¢50.00 GH¢45.00 GH¢45.00
Sales volume (units) 65,000 110,000 125,000 80,000

Incremental fixed costs are GH¢1,200,000 per annum. The sales prices allow for expected
price increases over the period. However, cost estimates are based on current costs, and do
not allow for expected inflation in costs. Inflation is expected to be 3% per year for variable
costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure
items. Tax on profits is at the rate of 30%, and tax is payable in the same year in which the
liability arises.

Sabir Company uses a four-year project appraisal period, but it is expected that the
equipment will continue to be operational and in use for several years after the end of the
first four-year period.

The company’s cost of capital for investment appraisal purposes is 10%. Capital projects
are expected to pay back within two years on a non-discounted basis and within three years
on a discounted basis. Tax allowable depreciation will be available on the equipment at the
rate of 25% per year on a reducing balance basis. Any balancing allowance or balancing
charge is not attributed to a project unless the asset is actually disposed of at the end of the
project period.

Required:
a) Calculate the net present value (NPV) of the project. (11 marks)

b) To the nearest month, calculate the non-discounted payback period and the discounted
payback period (4 marks)

c) Explain the meaning of market volatility in financial markets. (3 marks)

d) Explain the difference between a bull and bear market. (2 marks)

(Total: 20 marks)

Page 7 of 21
QUESTION FIVE

a) Explain THREE (3) motives for holding cash. (3 marks)

b) Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on

only cash basis. The company’s current annual sales are GH¢10 million. The operating cost
structure is as follows:

 Cost of sales 55% of sales

 Staff cost 10% of sales
 Marketing and distribution cost 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in
the light of the current tightness in liquidity in the market, the drive by other competitors,
and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers
are offered 1-month credit and a new credit department is set up to assess and monitor this
credit sales. The monthly cost of running this credit department is GH¢20,000 and bad debts
is expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:
i) Calculate the total profit before tax before the introduction of the new policy. (4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy. (6 marks)

iii) Advise management whether the initiative should be undertaken. (3 marks)

c) Explain FOUR (4) differences between a foreign currency swap and an interest rate swap.
(4 marks)

(Total: 20 marks)

Page 8 of 21
SOLUTION TO QUESTIONS

QUESTION ONE
a) Investing decisions
Investing decisions are decisions that relate to the acquisition and disposition of
assets that would generate cash flows for the firm. The objective of investing
decisions is to achieve optimal allocation of limited resources to investment
opportunities.
Directors are expected to make investing decisions such as the following:
 Deciding on growth strategy; whether to employ an internal growth strategy,
which involves pursuing internally developed projects, or external growth
strategies, which involves acquisitions and mergers
 Deciding on the proportion of the components of assets needed to achieve the
objectives of the firm. For instance, the proportion of property, plant and
equipment in the total portfolio of assets.
 Deciding on the replacement of assets.
 Deciding on disinvestments.
 Deciding on how much to allocate to competing investment opportunities.
[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]
(3 marks)

Financing
Financing decisions are related to the mix of the various types if finance the firm
should use. The objective of financing decisions is to minimise the risk and cost of
finance.
The directors are expected to financing decisions such as the following:
 Deciding on the blend of equity and debt in the financing structure.
 Deciding on the proportion of prior-charge capital in total capital.
 Deciding on the method of issuing new securities.
 Deciding on whether to obtain a stock market listing.
 Deciding on whether to issue securities in international markets.
[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]
(3 marks)

Dividend
Dividend decisions are related to payment of dividend and retention of earnings
for reinvestment. The objective of dividend decisions is to achieve a balance
between meeting shareholders expectation of current dividend and reinvesting
enough earnings to achieve targeted growth.
The directors are expected to make dividend decisions such as the following:
 Deciding on whether to recommend payment of dividend or reinvestment of
earnings.
 Deciding on the amount of dividend to recommend.

Page 9 of 21
 Deciding on the method of paying a dividend. Whether to pay cash dividends or
use alternatives such as stock dividends and share repurchase.
 Deciding on whether to capitalize previously retained earnings through a bonus
share issue.

[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]

(3 marks)

Relevant factors in the external environment

Directors should consider the following factors in the external business
environment when making financial decisions:
 Laws and regulations
 Economic factors
 Ecological issues
 Ethical issues
[Marks allocation: 2 factors @ 0.5 marks each = 1 mark]

b)

i) The degree of operating leverage (DOL)

The DOL of Firm A is 1.26, and that of Firm B is 1.76:

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑂𝐼
𝐷𝑂𝐿 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

Firm A Firm B
% change in Revenue -40.0% -40.0%
% change in NOI -50.5% -70.2%
% change in NI -65.6% -199.7%

−50.5%
𝐷𝑂𝐿𝐴 = = 1.26
−40.0%

−70.2%
𝐷𝑂𝐿𝐵 = = 1.76
−40.0%

Page 10 of 21
 Alternative formula:
The DOL may be computed as under using figures from the previous year (but not
the new year)

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
𝐷𝑂𝐿 =
𝑁𝑂𝐼

480 − 288
𝐷𝑂𝐿𝐴 = = 1.26
152

372 − 74.4
𝐷𝑂𝐿𝐵 = = 1.75
169.6

Implication:
The DOL assesses the volatility in operating profit to changes in revenue. It is high
when the firm uses more fixed costs than variable costs in its operating cost
structure. Firm B, which has a higher DOL, presents a higher business risk to
Groupe Trojan than Firm A, which has the lower DOL. The implications for the
capital structure decision is that Firm A, which has the lower DOL, could have
higher debt in its capital structure than Firm B, which has a higher DOL.

[Marks allocation: Computation of DOL = 2 marks each; advice on risk and

implications for capital structure design = 1 mark] (5 marks)

ii) The degree of financial leverage (DFL)

The DFL of Firm A is 1.3 and Firm B is 2.84:

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝐼
𝐷𝐹𝐿 =
% 𝑁𝑂𝐼

−65.6%
𝐷𝐹𝐿𝐴 = = 1.30
−50.5%

−199.7%
𝐷𝐹𝐿𝐵 = = 2.84
−70.2%

Page 11 of 21
 Alternative formula:
The DFL may be computed as under using figures from the previous year (but not
the new year)

𝑁𝑂𝐼
𝐷𝐹𝐿 =
𝑁𝑂𝐼 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡

152
𝐷𝐹𝐿𝐴 = = 1.30
152 − 35

169.6
𝐷𝐹𝐿𝐵 = = 2.85
169.6 − 110

Implication:
The DFL assesses the volatility in net income to changes in operating profit. It
indicates the level of financial risk. Firm B, which has a higher DFL, presents a
higher business risk to Groupe Trojan than Firm A, which has the lower DFL. The
implications for the capital structure decision is that Firm A, which has the lower
DFL, could have higher debt in its capital structure than Firm B, which has a higher
DFL.

[Marks allocation: Computation of DFL = 2 marks each advice on risk and

implications for capital structure design = 1 mark] (5 marks)

(Total: 20 marks)

EXAMINER’S COMMENT
This question consisted of a) and b) parts with two sub questions i) and ii) under b).
The a) covered the objectives of fundamental decision areas in Finance in the areas of
Investing, Financing and Dividend decisions and the external environmental factors
to be taken into consideration in making those decisions. This part was essay and the
performance of the candidates was above average and contributed to passing rate of
candidates. This area covered 10 marks.
The b) aspect centred on computation of the degree of operating leverage and financial
leverage for part i) and ii) respectively for Firms A and B and advise to the Directors
the relative level of business and financial risk associated with the two subsidiaries
and the implication of that on capital structure design. Each aspect carried 5 marks
totalling 10 marks. The b) part of the question posed a challenge to the candidates on
the computation and interpretation and advice. Even though the question appeared

Page 12 of 21
clear, majority of the candidates struggled to compute, interpret and advice but few
candidates were able to do all and scored the maximum marks.

On the average about 10% of the candidates got pass mark in this question. The a) part
was best answered and b) poorly answered. Overall, it was a below average
performance question and was the second worst answered question in the overall
paper and contributed to the drop in the pass rate in the Subject.

QUESTION TWO

i) Calculation of the value of Staygood using P/E ratios:

Staygood’s share price = 12 x 37p = GH¢4.44 (3 marks)

Note:
Any candidate who uses an adjusted P/E ratio in a 30% range should be given full
credit.

We will assume that the market will expect Restwell to achieve a level of return on
Staygood comparable to that which it makes on its own assets. Hence:
Total market value = 5m x GH¢4.44 = GH¢22.2m (3 marks)

ii) To use the Gordon growth model we must find g and kₑ

5 27
Here g is given by √15 – 1 = 12.47 per cent
Kₑ for Staygood is 20% higher than Restwell, therefore:
Kₑ = 15% x 1.20 = 18% (2 marks)
Therefore PO = (27 x (1.1247)) /(0.18 - 0.1247) = GH¢5.49 (3 marks)
Total market value = 5m x GH5.49 = GH¢27.46m (3 marks)

iii) Using future cash flows and discounting these to infinity using Restwell’s WACC
as a discount rate:
Present value = (GH¢2.5m / (0.12-0.05)) + (5/1.122) = GH¢39.7m (6 marks)

(Total: 20 marks)

EXAMINER’S COMMENT
Question two was on takeover in the hotel and leisure industry where Restwell Ltd
was to take over a smaller Company called Staygood Ltd. The question was centred
on estimating the value of Staygood under three different methods namely:
i) Price/Earning

Page 13 of 21
ii) Gordon growth model and
iii) Discounted cash flow valuation
for 6 marks each for i) and iii) and 8 marks for ii) totalling 20 marks.

Candidates’ performance was very poor in this question on all the three aspects. It
was the price earning method that received moderate answers. Only few candidates
were able to answer this question and scored good marks. Additionally, the question
was too concentrated on only takeover valuation methods for the full 20 marks which
impacted negatively on candidates who could not answer that question and
influenced the overall decline in pass rate in this sitting.

The Overall performance in question was very poor and the worst answered with only
5% of the candidates getting pass in this question.

QUESTION THREE
a)
i) Instalment
1
1−
i nm
(1 + m)
PVA = PMT
i
m
[ ]

The present value of the payments, PVAn = Loan principal = GH¢500,000

Annual interest, i = 22%
Frequency, m = 4
Term (in years), t = 2
Number of periods, n = Term x Frequency = 2 x 4 = 8
1
1−
0.22 8
(1 + 4 )
500,000 = PMT
0.22
4
[ ]

Page 14 of 21
 500,000 500,000
𝑃𝑀𝑇 = = = 78,932.01
1 6.334565988
1−
0.22 8
(1 + 4 )
0.22
4
[ ]
That is, the company will be required to pay GH¢78,932.01 at the end of each
quarter to amortize the loan.

[Marks allocation: Interest factor = 1; Computation of instalment = 1; Final

answer = 1] (3 marks)

ii) Amortization schedule

Period Interest Instalment Principal Outstanding
repayment balance

0 - - - 500,000.00

1 27,500.00 78,932.01 51,432.01 448,567.99

2 24,671.24 78,932.01 54,260.77 394,307.23

3 21,686.90 78,932.01 57,245.11 337,062.12

4 18,538.42 78,932.01 60,393.59 276,668.53

5 15,216.77 78,932.01 63,715.24 212,953.29

6 11,712.43 78,932.01 67,219.57 145,733.72

7 8,015.35 78,932.01 70,916.65 74,817.07

8 4,114.94 78,932.01 74,817.07 -

[Marks allocation: Interest = 2 marks; Instalment = 1 mark; Principal

repayment = 2 marks; Outstanding balance = 2 marks] (7 marks)

Page 15 of 21
b) i)

Month GRR (%) Interest Fixed Interest Net Settlement

Rate
(A) (B) (Variable) (Fixed) (F)
(D)
(C) (E) 22% x (E – C)
1m
GRR+3%

X GHS 1m

1 16 15,833 21% 17,500 (1,667)

2 18 17,500 21% 17,500 0

3 20 19,166 21% 17,500 1,666

4 19 18,333 21% 17,500 833

5 18 17,500 21% 17,500 0

6 17 16,667 21% 17,500 (833)

C= 3 marks E= 2 marks F= 3 marks

(8 marks)

ii) It is a hedge because the variable rate Asanka will receive will compensate the
variable rate Asanka will pay to its Bankers it borrowed variable from and will be
left with only the fixed interest payment. Settlement will be on net basis.
This takes off the uncertainty and volatility in monthly interest payment from
Asanka. (2 marks)

(Total: 20 marks)

EXAMINER’S COMMENT
Question three consisted of a) and b) parts with sub questions i) and ii) under each.
The a) i) covered computation of quarterly instalments for 3 marks and ii) on
amortisation for 7 marks. The b) part was on interest rate hedge with i) on completion
of various interest rates: variable, fixed and net settlement for 8 marks and ii) on a
follow up on whether it was an interest rate hedge for 2 marks totalling 10 marks. The
overall marks for the question was 20 marks.
The a) part received good answers and a reasonable number of the candidates
understood the question and scored the maximum marks in both i) and ii). The b) part
performance though average was below the a) part. The question required
determination of the interest rates and computation of the various interest amounts
based on the notional principal in the question for the variable and fixed interest

Page 16 of 21
amounts and the net settlement in amount. Some candidates did very well in
completing the table while others did that in percentages.
The overall performance was average. 17% of the candidates got pass in this question
and the third best answered question in the paper.

QUESTION FOUR

a) Workings

Year Written down Tax Tax benefit

value allowable (30%)
depreciation
GH¢000 GH¢000 GH¢
2,000
1 (500) 500 150
–––––
1,500
2 (375) 375 113
–––––
1,125
3 (281) 281 84
–––––
844
4 (211) 211 63
–––––
c/fwd 633
–––––

NPV calculation

Year 1 2 3 4
GH¢ GH¢ GH¢ GH¢
Average sales price 73.55 76.03 76.68 81.86
Average variable 51.50 53.05 49.17 50.65
cost
Contribution per 22.05 23.98 27.51 31.21
unit
Sales units 65,000 110,000 125,000 80,000

Page 17 of 21
 GH¢000 GH¢000 GH¢000 GH¢000
Total contribution 1,433 2,528 3,439 2,497
Fixed costs (1,248) (1,298) (1,350) (1,404)
Taxable cash flow 185 1,230 2,089 1,093
Tax (30%) (56) (335) (627) (328)
129 861 1,462 765
Tax benefits 150 113 84 63
Net cash flow 279 974 1,546 828
Discount factor, 10% 0.909 0.826 0.751 0.683
Present values 254 805 1,161 566

GH¢000
Total present values of net cash 2,786
flows
Year 0 Capital outlay (2,000)
–––––
Project four-year NPV 786
–––––

Note: There is no balancing allowance for the equipment for tax purposes, because
the equipment will not be disposed of after four years. It would be reasonable to
suggest that some terminal value should be included for the equipment at the end
of Year 4, but there is insufficient information available on which to make such a
valuation.

If the terminal value of the equipment is assumed to be its written down value at
the end of Year 4, this could be included in the project cash flows and would
increase the project NPV.

[Average variable = 2 marks, Contribution per unit 0.5 mark, Sales units = 0.5
mark, Total contribution= 1-mark, fixed contribution = 2 marks, tax = 1 mark,
tax benefits = 2 marks, present value = 1 mark and NPV = 1 mark] (11 marks)

Page 18 of 21
b) Payback and discounted payback

Year Cash Cumulative Discounted Cumulative

flow cash flow cash flow discounted cash
flow
GH¢000 GH¢000 GH¢000 GH¢000
0 (2,000) (2,000) (2,000) (2,000)
1 279 (1,721) 254 (1,746)
2 895 (826) 739 (1,007)
3 1,546 720 1,161 154
4 828 1,548 566 720
Non-discounted payback period = 2 years + [(826/1,546) × 12] = 2 years 6 months
(2 marks)
Discounted payback period = 2 years + [(1,007/1,161) × 12] = 2 years 10 months
(2 marks)

c) Market volatility
Market volatility in financial markets is a measure of the extent to which the price
of a financial security (such as a share’s market price), or a market as a whole, or
an interest rate, or a currency, or a commodity changes over time.
High volatility means rapid and large changes in a price or rate over a short period
of time. Low volatility means smaller and less frequent price changes.
Volatility refers to price movements in both directions, up and down. If prices
move over time always in the same direction (either up or down, but not both) this
does not mean high volatility. Volatility implies uncertainty about the way that
prices will move next, and by how much.
High volatility creates high financial risk. Investors will want higher returns to
invest in financial instruments where price volatility is high. (3 marks)

d) Bull and bear markets

In a bull market, prices on the whole move upwards continually over time. For
example, in a bull stock market, share prices on the whole continue to rise over
time.
In a bear market, prices on the whole move downwards continually over time. For
example, in a bear stock market, share prices on the whole continue to fall over
time.
(2 points well explained for 2 marks)

(Total: 20 marks)

Page 19 of 21
EXAMINER’S COMMENT
Question Four was on project evaluation, and theory aspect on market volatility, bull
and bear markets and covered a) to d). a) was on Net Present Value Computation
(NPV) b) on payback period on both non discounted and discounted cash flow basis
whilst c) was market volatility in financial markets and d) and bull and bear markets.
The a) aspect was well answered generally but some candidates struggled to compute
the forecast variable and fixed cost over the 4-year period and how to handle the tax
allowable depreciation issues which impacted negatively on their answers.
The b) part also generally received good answers with some candidates scoring the
maximum marks.
The c) and d) which were theory questions also got good answers and pushed
candidates into the pass zone in the question.
The overall performance was good and 23% of the candidates passed in this question.
It was the second-best answered question in the paper and contributed to the overall
pass rate.

QUESTION 5

a) Cash is held for various reasons. The three motives for holding are as follows:
 Transitionary motive for balance short term cash needs of inflows and outflows;
 Precautionary motive to meet contingent or unexpected cash needs as and when
they occur;
 Speculative motive which is to take advantage of investment opportunities as and
when they occur or come.
(3 points explained for 3 marks)

b)
i) GH¢
Sales 10,000,000
Cost of sales (55% x 10m) (5,500,000)
Gross profit 4,500,000
Staff cost (10% x 10m) (1,000,000)
Marketing & Distribution Cost (15% x 10m) (1,500,000)
Net profit before tax before the policy 2,000,000
(4 marks)

ii) GH¢
Sales (150% x10m) 15,000,000
Cost of sales (55% x 15m) (8,250,000)
Gross profit 6,750,000
Staff cost (10% x 15m) (1,500,000)
Marketing & Distribution Cost (15% x 15m) (2,250,000)
Credit Admin Cost (20,000 x12) (240,000)

Page 20 of 21
 Bad Debts (4% x 5m (15-10m)) (200,000)
Interest or Financing Cost (1/12 X 5m x 25%) (104,167)
Net profit before tax after the policy 2,455,833
(6 marks)

iii) Profit before tax after the policy 2,455,833

Less profit before tax before the policy 2,000,000
Change 455,833

New policy resulted in incremental profit of GH¢ 455,833 and should be

implemented
(3 marks)

c) A foreign currency swap is an agreement to exchange principal and interest

payment in one currency for equivalent principal and interest payment in another
currency. It is used usually to raise liquidity in one currency by utilizing the
surplus liquidity in another currency without converting the currency to create
exchange rate risk. It can also be done for trading purposes. Each party is
borrowing and paying interest on the currency is short in liquidity by utilizing the
liquidity surplus in has in the other currency.
(2 marks)

An interest rate swap is an agreement between two parties to exchange interest

payments on an agreed Notional amount in the same currency for a specific
maturity. It could be from floating to fix or from fix to floating. One party pays
floating and receives or the vice versa The floating rate is referenced to a market
benchmark like LIBOR and changes from time to time based on the changes in the
benchmark.
(2 marks)
(Total: 20 marks)
EXAMINER’S COMMENT
The question five was also a combination of theory and quantitative covering a) to c).
The a) part was theory on three motives of holding cash for 3 marks. This part received
the best answers with almost every candidate answering and getting good marks.
The b) aspect which carried 13 marks and covered i) to iii) was on the introduction of
credit policy in the household consumable business and candidates were to measure
the performance before the introduction of the credit policy and performance after the
policy and advise management whether the new policy should be introduced or not.
Most candidates got this question right and scored the maximum marks.
The c) aspect which was theory and on the differences between foreign currency and
interest rate swaps performance was above average for 4 marks. The overall marks for
the question was 20 marks.
Question 5 received the best answers and best performance in the paper. 66% of the
candidates passed in this question and contributed to the overall pass rate of the
candidates. The questions were precise and unambiguous and well understood by the
candidates.

Page 21 of 21
 SOLUTION FINANCIAL MANAGEMENT NOV 2010

SOLUTION 1

(a) Maximising means seeking the best position outcome and satisfying means seeking only an
adequate outcome.

(b) Stakeholders
(i) Community – social responsibility and less polution.
(ii) Employees – high wages and employment security
(iii) Management – attractivce remunerative packages and growth in the business
(iv) Shareholders – high dividend and growth in share price
(v) Others are trade suppliers, trade customers debt providers, government etc.

(c) 5/10 net 90 credit basis implies a 5% cash discount if settlement is made within 10 days, or
discount lost if payment is made after 10th day.

Rate (R) = l x l, where l is the discount lost P is the principal and T is Time period in a year
P T after the discount qualification period.

=> l = 0.05 x 250,000 = GHS12,500

=> R = GHS12,500 x 1/90-10)/360

(GHS250,000 – GHS2,500)
= 23.68%

(d) (i) Investment – exploration of new mining concessions and the acquisition of modern
mining equipments to increase yield.

(ii) Financing – Extra financing needed might have to be suspended

(iii) Dividend Policy Decisions – Sacrificing shareholders wealth for the benefit of other
stakeholder demand.

SOLUTION 2

i) a) 12.45% discount = 12.45% x 100 = GHS12.45

For 91-days, the discount = 12.45 x 91 = GHS3.1125

365

b) As simple interest
Investor pays 100 – 3.1125 = GHS96.8875
:. Interest % per 91 days = 3.1125 = 3.21%
96.8875
 c) Interest per annum simple interest
3.21% x 365 = 12.84% p.a.
91

d) Compound annual interest

365/91 4
(1 + 3.21%) - 1 = (1.0321) - 1 =
e) Treasury bills do not pay interest up front because the purchase amount (cost of treasury
bills) is deducted from your account today.
If you do not have this amount you cannot buy the Treasury bill.

ii) a) . Governments sells at face vlaue means the yield is 16% per annum 9same as
coupon rate).
. The demand for 2% points risk premium implies the yield on xx bonds = 16% +
2% = 18% p.a.

For GHS10 face value bond, the interest cannot semi annually is
8% x GHS10 = GHS0.8

The PV of six semi-annual interest amount

0 1 2 3 4 5 6
0.8 0.8 - - 0.8 0.8 + 10

PV = 9% annuity for 6 periods + PV of GHS10

= 0.8 x 4.486 + 10 x 0.596
= 3.5888 + 5.96
= GHS9.5488

b) Firm nets 9.5488 – 0.5 = GHS9.0488

Thus must sell GHS100 million
9.0488

= 11.051189 million bonds

SOLUTION 3

Looser Ltd
_
(a) Re = 8 + 1.5 (10) (b) ßA = 1.5 6
10
= 23% = 0.9

_
(c) RA = 8 + 0.9 (10) (d) = 17%

= 17%
(e) Yes (f) = 17%

ßE = 0.9 10 _
9 (g) R = 8 + 1.2 (10)
= 1 = 20%

SOLUTION 4

Asuo Limited

a)
Year Cashflow PV @ 10% PV @ 12%
0 Investment (335,600) 335,600 335,600
1-5 Renevue 350,000 1,326,500 1,260,000
1-5 Variable cost (150,000) (568,500) (540,000)
1-5 Fixed cost (110,000) (416,900) (396,000)
5 Scrp value 35,000 21,700 19,950
Positive NPV’s 27,200 8,350

In view of the Positive NPV at 10% the project should be accepted.

b) Sensitivity
(i) Variable Costs
The percentage change in variable costs required to change the decision is obtained by
expressing the NPV of the project as a percentage of the PV of variable costs.

Sensitivity = 27,200 x 100 = 4.78%

568,500

A rise of 4.78% in variable costs causes the decision to change.

(ii) Scrap Value

Sensitivity = 27,200 x 100 = 125.3%
21,700
It would have to cost 25.3% of 35,000 = GHS8,855 to complete the project before the
decision changes.

(iii) Discount Rate

Sensitivity to discount rate is found via the project’s IRR

IRR = 10% + 27,200 (12% - 10%)

27,200 – 8,350

= 12.9% say 13%

The discount rate must rise from 10% to 13% before the decision would change.
c) Probability of Failure
For the decision to change, the PV of the revenue must fall by GHS27,200. This represents a
fall in the annual revenue of GHS27,200/3.79 = GHS7,177

This represents 7,177 = 1.50 std deviation

4,800

The probability of failure = (0.5 - 0.4332)

= 0.0668 or 6.68%

SOLUTION 5

(a) (i) The synergy is the PV of the increased cash flow GHS960,000 in perpetuity at 24% has 1
PV = 960,000 = GHS4,000,000
0.24
(ii) Alternative A: Cash offer
Paying GHS15 million for a firm worth GHS12 million has a cost of
GHS15.12 million = GHS3 million

Alternative B: Issue shares

PV of combined firm = PV of K. Asante + PV Pumbros + Synergy
= 40m + 12m + 4m
= GHS56 m
25% of this equals 25% of 56m = GHS14 m
Cost of share offer = GHS14m - GHS12m
= GHS2 million

(iii) NPV of each alternative to K. Asante

NPV = Gain - Cost

Cash Alternative:
Gain = GHS4m
Cost = GHS3m
NPV = GHS4 - GHS3 = GHS1m

Share Alternative
Gain = GHS4m
Cost = GHS2m
NPV = GHS4m – GHS2m = GHS2m

(iv) NPV to Pumbros shareholders

Cash offer:
Receive GHS15m in exchange for GHS12m coupon
Cost = 0
NPV = GHS3m

Share offer too Pumbros

Gain: Receive GHS14m and give up GHS12m
(b) FV = PV (l + r)n
FV = 2000; PV = 1000; r = 12%

ln FV = n ln (i+ r)
PV
= r n = ln FV = ln 2000
PV 1000
___________ _________
ln (i + r) ln 1.12
THE INSTITUTE OF CHARTERED
ACCOUNTANTS (GHANA)

NOVEMBER 2011 EXAMINATIONS

(PROFESSIONAL)

PART 3

FINANCIAL MANAGEMENT

(Paper 3.4)

Attempt ALL Questions

TIME ALLOWED:

Reading & Planning - 15 Minutes

Workings - 3 Hours

Page 1 of 6
QUESTION 1

(a) There is growing concern in the corporate world that organisations need to be socially
responsible in order to enhance shareholders wealth. However, others are also of the
opinion that social responsibility leads to erosion of corporate profitability.

You are required to briefly explain whether value maximisation is inconsistent with social
responsibility.
(5 marks)

(b) Briefly outline and explain the factors that influence the dividend policy of a company.
(5 marks)

(c) Jomec Ltd is currently financed as follows:

Cost Book Value Market Value

% (GHS’m) (GHS’m)
Ordinary share capital 12.5 100 250
Debentures 6 60 50
160 300

Jomec Ltd wishes to expand its business, for which a further GHS100 million of finance is required.
The following options are being considered.

Option (A) takes on GHS50 million debt plus GHS50 million equity; or

Option (B) takes on GHS80 million debt plus GHS20 million equity.

It is expected that the cost of the new debt will match that of the existing debt. However, due to the
increased financial risk, it is estimated that the cost of equity will rise by 0.5% for option (A) and
2% for option (B).

You are required to compute the existing WACC and the new WACC under the two options.
(10 marks)

(Total: 20 marks)

QUESTION 2

(a) Obuo Limited, an all equity financed food processing company is planning to raise debt
finance to alter its capital structure. The managing director has called on you for financial
advice.

Page 2 of 6
Required:

Outline five (5) main factors you would propose to the managing director for consideration in
choosing between equity finance and debt finance as sources of capital.
(5 marks)

(b) The Board of directors of Nhyira bank Limited has recently passed a resolution to raise
capital through right issue of shares to meet its minimum capital requirement before the
deadline set by the Central Bank. The company intends to issue one (1) share for every 3
shares held by the existing shareholders at a 10% discount to its current share price. The
company currently has 3 million ordinary shares in issue at a book value price of GHS1.00
per share.

Nhyira Bank Limited maintains a payout ratio of 50% and earnings per share is currently
GHS0.80. Dividend growth of 5% per annum is expected for the forseable future and the
company’s cost of equity is 12%. Issue cost arising out of the new issue of share shall
amount to GHS300,000.

Required:

a. Calculate,

(i) the market price per share (1 marks)

(ii) the capitalisation of Nhyira bank Limited (1 marks)

b. Assuming the right issue takes place, calculate

(i) the right issue price per share (2 marks)

(ii) the cash proceeds from the right issue (2 mark)

(iii) the theoretical ex-right price (2 marks)

(iv) the market capitalisation after the right issue (2 marks)

c. Ten years ago, God’sway Ltd issued GHS2.5 million of 6% discounted debenture at GHS98
per GHS100 nominal. The debentures are redeemable in 6 years from now at a GHS2
premium over nominal value. They are currently quoted at GHS79 per debenture, ex
interest. The company pays tax at the rate of 30%.

Required:

Estimate the after tax cost of the debenture. (5 marks)

(Total: 20 marks)

Page 3 of 6
QUESTION 3

(a) Kukua holds two bonds: a 30 year coupon bond with a face value of GHS30 million paying
annual coupon of 8% and a 30 year zero coupon bond with a face value of GHS30 million.
Suppose interest rates increase from 8% to 9%.

Required:

Which bond will have the greater decline in price, the 30-year bond paying annual coupon of 8% or
a 30-year zero coupon bond?
(4 marks)

(b) Nana is applying to Ghana Home Loans for a mortgage of GHS200,000. The company is
quoting 6% interest per annum. Nana would like to have a 25-year amortization period and
wants to make a monthly payment.

Required:

What will Nana’s payments be per month? (4 marks)

(c) An investment in an item of equipment would cost GHS75,000. It is estimated that sales in
the first year would be GHS60,000 rising by 5% a year for the next four years. Variable
costs would be 50% of sales. Annual fixed costs would be GHS20,000 in the first three
years, rising to GHS30,000 in years 4 and 5. Fixed costs of 40% would be avoidable if the
project did not go ahead. The scrap value of the equipment at the end of year 5 would be
GHS5,000. The project would also require an investment in working capital of GHS15,000
at the start of year 1 rising to GHS20,000 at the start of year 2 and to GHS25,000 at the start
of year 4. The company’s cost of capital is 9%.

Required:

Calculate the NPV of the project and suggest whether it should be undertaken.
(12 marks)

(Total: 20 marks)

QUESTION 4

(a) Outline four (4) advantages and four (4) disadvantages of preference share capital as a
source of finance.
(4 marks)

Page 4 of 6
(b) The Statement of Financial Position of XDS Ltd as at December 2010 was as follows:

Liabilities GHS000 Assets GHS000

Share capital 200 Plant & Equipment 500

Income surplus 140 Stock 300
Long term loans 360 Accounts receivable 240
Short term loans 200 Cash and Bank 60
Account payables 200 ____
1,100 1,100

Sales for the year were GHS600,000 and are expected to increase by 20%. XDS Ltd expects
a profit margin of 4% and dividend pay out ratio of 35%.

You are required to compute the amount of external funds that XDS Ltd requires for 2011.
(6 marks)

(c) A company is offered a contract which has the following terms:

An immediate cash outlay of GHS30,000 followed by cash inflow of GHS35,800 after 3

years.

What is the company’s rate of return on this contract? (4 marks)

(d) Explain briefly what you understand by the following terms:

(i) Systematic risk

(ii) Unsystematic risk
(iii) Weak Form Efficient Market
(iv) Securities market line
(6 marks)

(Total: 20 marks)

QUESTION 5

(a) The Board of Directors of Onyameaseman Bank is launching a bid to take over Graceland
Bank as part of its strategy to penetrate the Okuapeman banking industry. The following
information was extracted from the 2010 financial statement of Graceland Bank.

Shareholders fund GHS300,000

Ordinary shares GHS120,000
Dividend per share 50 Gp
Dividend growth rate into perpetuity 5%

Page 5 of 6
 Additionally it was realised that Fixed Assets costing GHS80,000 had not been revalued
since 2001 and it is expected to have a market value of GHS120,000. Kofi Abrente was
reported dead three weeks ago so his debt of GHS10,000 cannot be realised.

Expired inventory of GHS5,000 has to be disposed of. Zoomtiger will charge GHS8,000 to
incinerate these items.

You are required to advise Onyameaseman about:

(i) the market value of Graceland bank using two valuation models assuming Onyameaseman
Bank expects 25% rate of returns.
(5 marks)

(ii) State and explain clearly five (5) possible steps that management of Graceland Bank may
employ to prevent the takeover.
(5 marks)

(b) Mallam Attah Ltd needs to increase its working capital by investing to the tune of
GHS200,000. The company has two alternative options as follows:

Options One: To take a trade discount granted on the basis of 2/20 net 50.

Option Two: Borrow from the Bank with an interest rate of 25% per annum. The bank requires a
matching contribution of 20% to be put in a current account yielding no interest. The full loan
amount will be booked in the name of Mallam Attah Ltd.

Required:

Advise the company on which option it should select.

(5 marks)

(c) a. What are derivatives?

b. Explain and give an example each of what swaps, forwards, features and options are.
(5 marks)

(Total: 20 marks)

Page 6 of 6
 FINANCIAL MANAGEMENT NOV 2011

SOLUTION 1

(a) Value maximisation is a way of giving returns to the shareholders on their investment. The
return is derived from the regular dividend payments they receive and the capital appreciation
of their share prices.

Meeting this objective must be in tandem with meeting the exceptions of the community. A
company once established belongs to the community. It provides employment to the people,
produces quality goods and services to meet the safety standards of the consumers.

A company as a going concern must not be hostile towards the community since such an action
may compel the community to boycott the consumption of the company’s product. This may
lead to profit decline and consequently results in no-payment of dividends and share price
reduction which may force the company into bankruptcy.

(b) Various factors influence a firm’s dividend payout decisions:

1. Investment opportunities

2. Cashflow/liquidity situation

3. Legal requirement

4. Taxation

5. Interest payment obligations

6. The effect of paying dividend on shareholders wealth

7. Transaction cost of raising funds.

(c) Existing WACC = (250/300 x 12.5%) + (50/300 x 6%)

= 11.42%

Cost Option (A) Option (B)

GHS’m GHS.m
Ordinary share capital 12.5% 300 270
Debentures 6 100 130
400 400

Page 1 of 10
 FINANCIAL MANAGEMENT NOV 2011

New WACC:

Option (A) (300/400 x 13%) + (100/400 x 66%) = 11.25%

Option (B) (270/400 x 14.5%) + (130/400 x 6%) = 11.74%

Under Option (A)

This option results in a moderate increase in gearing ratio, the WACC decreases, whilst the cost of
equity did rise by a small amount, the effect of the increased tranche of cheap debt out weighted this.

Under Option (B)

This option results in a much more significant rise in gearing-nearly doubling the percentage of debt –
and is therefore accompanied by a far greater rise in the cost of equity. This now dominates, and the
WACC rises.

SOLUTION 2

(a) There are a number of factors that should be considered by Obuo Limited, including the
following:

1. Gearing and Financial Risk

Equity finance will decrease gearing and financial risk whilst debt finance will increase
them.

2. Availability of Security
Debt usually needs to be secured on assets by either a fixed charge or a floating charge.
Equity finance is normally security free source of funds.

3. Control Issues
A right issue will not dilute existing pattern of ownership and control unlike an issue of
shares to new investors. Therefore new issue of shares has control implications in the
existing shareholder. Issuing traded debt usually do not affect the control and ownership
pattern since debt holders are not owners.

4. Economic Expectation
If Obuo Limited expects buoyant economic condition and increasing profitability in future,
it will be more prepared to take on fixed interest debt commitment than if it believes
difficult trade conditions lie ahead.

5. Taxation
Debt finance is usually considered to be cheaper as compared to equity finance since
interest on debt at tax deductible whilst dividends are not.

Page 2 of 10
 FINANCIAL MANAGEMENT NOV 2011

6. Target Capital Structure

If the primary objective of Obuo Limited is to maximise the wealth of shareholders, it
should seek to minimise its WACC. In practical terms, this can be achieved by having
some debt in its capital structure, since debt is relatively cheaper than equity whilst
avoiding the extremes of too little gearing or too much gearing.

i. Market price per share

DPS = 0.5 x 0.80 = GHS0.40 per share
Po = Do (1 + g)
r–g
Po = 0.40 (1.05) = GHS600
0.12 – 0.05

ii. Capitalisation
Market Capitalisation=GHS6 x 3m shares = GHS18m

(b) i. Right issue price at 10% discount of the current market share price
= 0.9 x GHS6.00 = GHS5.40

ii. Cash raised

New shares issued = 3m/3 = 1 million shares
Cash raised = 1 million shares x GHS5.4 = GHS5,400,000

iii. Theoretical ex-right price = 3 shares @ 6.0 = 18

1 share @ 5.40 = 5.4
4 23.4
Ex-right price = GHS23.4 = GHS5.85
4

iv. Market capitalization after the right Issue GHS

Value before R1 = 18m
Cash raised from R1 = 5.4m
23.4m
Less issue cost (0.30)
23.4m

. .
NB: The issue cost result is a decrease – the market value of the company and therefore a decrease –
wealth of shareholders equivalent to GHS0.60 (6.0 – 5.4.

(c) Cost of Debt

After tax interest = 6(1 - 0.30) = 4.2%
Capital gain GHS102 – 79 ÷ 6 years = 4.85
79 9.05% per year

Page 3 of 10
 FINANCIAL MANAGEMENT NOV 2011

Estimating
PV = (…….. x Interest) + R
(l + r)n

NVP at 10%
(79) = (GHS4.20 x 4.355) + 102
(1.10)6

75.87 = GHS18.29 + GHS57.58

NVP - GHS3.13

NVP at 8%
(79) = (4.2 x 4.623) + 102
(1.08)6

83.70 = 19.42 + 64.28

NRI 4.7

IRR = a + NPva (b – a)
NPva + NPvb

IRR = 8 = 4.7 (10 - 8) = 9.2

7.83

Cost of redeemable Debt = 9.2%

SOLUTION 3

(a)
8%, 30-year Bond
PV = C l- l + FV
(l + r)t (l + r)t
r

C = 0.08 x 30,000,000
= 2,400,000
:. PV = 2.4 (11.2575) + 30/10.0626
= 27.018 + 2.981
= GHS29.99m

Page 4 of 10
 FINANCIAL MANAGEMENT NOV 2011

30-year Bond with increase in rate from 8% to 9%

2.4m 1 – 1 + 30m
(1.09)30 (1.09)30

2.4 (10.2733) + 30/13.26767

24.65592 + 2.261
= GHS26.92m

% change in Present Value

29.99 - 26.92 x 100

29.99

= 10.27%

Zero coupon Bond, when rate = 8%

PV = FV = 30m
(l + r)t (1.08)30

= GHS2.981m

Zero coupon Bond, when rate = 9%

PV = FV = 30m
(l + r)t (1.09)30

= GHS2.261m

% change in Present Value

2.981 - 2.261 x 100

2.981
= 24.16%

The bond with the Zero coupon will have the greatest decline in price.

(b) PV = C l– l
(l + r)t
R

PV = 200,000, r = 0.06/12 = 0.005, t = 25 x 12 = 300

Page 5 of 10
 FINANCIAL MANAGEMENT NOV 2011

200,000 = C 1 - 1
(1.005)300
0.005

200,000 = C 1 – 0.22396
0.005

200,000 = C (155.208)

:. C = 200,000/155.208
= GHS1,285.59 per month

Workings

Variable Avoidable Operating

Year Sales Cost Fixed Cost Net Cash Flow

1 60,000 30,000 8,000 22,000

2 63,000 31,500 8,000 23,500
3 66,150 33,075 8,000 25,075
4 69,458 34,729 12,000 22,729
5 72,930 36,465 12,000 24,465
.
(c) Calculation of NVP of the Project

Working Net Op. Net Df @ Present

Year Equipment Capital Cash Flow Cash Flow 9% Value

(75,000)
0 (15,000) - (90,000) 1.000 (90,000)
1 (5,000) 22,000 17,000 0.917 15,589
2 - 23,500 23,500 0.842 19,787
3 (5,000) 25,075 20,075 0.772 15,498
4 - 22,729 22,729 0.78 16,092
5 5,000 25,000 24,465 54,465 0.650 35,402
12,368
Suggestion
The NVP is positive, and on the basis of these figures, the project would appear to be financially
worthwhile.

Page 6 of 10
 FINANCIAL MANAGEMENT NOV 2011

SOLUTION 4

(a)

(b) Total Assets - Payables x Increase in Sales - Profit Margin x New Sales Level
Previous Sales Previous Sales x Payout Ratio

= 1,100 - 200 x 120 - (0.04 x 720 x 0.35)

600 600

1.5 x 120 - (10.08)

180 - 10.08 = 169.92

External capital required 169.92

(c) The amount of GHS30,000 cash outflow may be treated as a principal which the company
deposit into an account that pays an unknown rate of interest but returns a compound amount of
GHS35,800 after 3 years.

Now, FV = PV (1 + r)n
Or 35,800 = 30,000 (1 + r)3
Or 35,800/30,000 = (1 + r)3
Or 1.193 = (1 + r)3
11.93%

(d) i. Systematic risk is the degree of uncertainty of an asset’s returns that cannot ne.
eliminated through diversification.

ii. Unsystematic risk is the degree of uncertainty of an asset’s returns that can be
eliminated through diversification.

iii. Weak form efficient market is a market efficiency whereby all past prices of an asset are
reflected in its current price.

Strong form efficient market states that current share prices reflect not only historical
share price patterns and current public knowledge, but also all possible information
about the company.

iv. Securities market line shows the relation between the expected return on an asset and
the asset’s beta.

Capital market line shows the possible portfolios that can be formed by combining the
risk-free asset and the market portfolio in different proportions.

Page 7 of 10
 FINANCIAL MANAGEMENT NOV 2011

SOLUTION 5

(a) (i) Market value based on Assets Valuation

GHS
Shareholders fund 300,000
Fixed assets revaluation (120,000 – 80,000) 40,000
Bad debts written off (10,000)
Expired stocks write off (5,000)
Incinerating cost (8,000)
Market value 317,000

Dividend Growth Model

Expected returns (k) = 25%
Growth Rate (g) = 5%
Dividend per share (D) = GP50 .. GHS50.50
Dividend per share after 9 year (D1) = 0.50 x 1.05 = 0.525

Market value = D1 x 120,000

k–g

= 0.525 x 120,000
0.25 – 0.05

= GHS2.625 x 120,000
= GHS315,000

(ii) Possible steps to thwart the takeover

Use Different Accounting Methods to Value Assets.

(1) Management may use different accounting methods to value the assets of the company
to render the bid inadequate.
Publish Future Profits of Long Term Contracts

(2) Management may release information about profits of future contracts to provide
evidence that the offer is inadequate.

Dispute Competency of Predator Company Management

Management may compare dividend and share price of Onyameaseman Bank to leading
banks in the industry with the view to proof that management of Onyameaseman Bank
management is not that competent as their performance fall short of others in the
industry.

Increased Dividend Payment

Management of Graceland bank may increase dividend payment as part of their
defensive ploy.

Page 8 of 10
 FINANCIAL MANAGEMENT NOV 2011

Lobbying
Management may lobby authorities such as the Securities and Exchange Commission
and Bank of Ghana arguing that the takeover may result in a monopoly and will not be
in the interest of society.

Merger
Management may also look for a friendly bidder and merge with them with the view of
frustrating the bid.

Asset Disposal
Management may also sell major assets of the bank to make the company unattractive
to Onyameaseman.

Management Buyout
Management may also buy the share of the company and go private.

Press Releases
Management may also use press releases or send email to shareholders explain why the
bid is inadequate.

(b) Option One Cost of Trade Discount:

Discount x 365
Net 50 – 20

Discount 2 x 200,000 = 4,000

100

Net 200,000 – 4,000 = 196,000

Cost = 4000 x 365 x 100 = 24.83%

196,000 50 - 20

Option Two Cost of Bank Loan:

Interest x 100
Net

Interest = 25% x 200,000 = 50,000

Net = 200,000 - 4,000 = 160,000

Cost = 50,000 x 100 = 31.25%

160,000

Page 9 of 10
 FINANCIAL MANAGEMENT NOV 2011

Take the trade credit ie Option One

(c) a. A derivative is an instrument whose value is derived from the value of one or more
underlying, which can e commodities, precious metals, currency, bonds, stocks, stocks
indices, etc. Four most common examples of derivative instruments are Forwards,
futures, Options and Swaps.

b. A forward contract is customized contract between two parties, where settlement take
place on a specific date in future at a price agreed today.

Futures are exchange traded contracts to sell or buy financial instruments or physical
commodities for future delivery at an agreed price. There is an agreement to buy or sell
a specified quantity of financial instrument/commodity in a designated future month at a
price agreed upon by the buyer and seller. The contracts have certain standardized
specifications.

 Options are the right to buy (a call) or sell (a put) a financial asset at a price negotiated
today.

 The buyer of a call is protected against an unexpected price increase in the spot market.

 The buyer of a put is protected against an unexpected fall in the price of an asset in the
spot market.

Page 10 of 10
QUESTION 1

(a) Explain the advantages and disadvantages of a currently unlisted company obtaining a
listing on the Stock Exchange (4 marks)

(b) (i) Describe the following terms:

1) “A company being over-capitalised”
2) “A company over-trading” (4 marks)

(ii) Explain how the situation of a company being over-capitalised arises and what are
the consequences thereof. (4 marks)

(c) A local bank is advertising that it pays depositors 6% compounded monthly, yielding an
effective annual rate of 6.168%. If GHC2,000 is placed in savings now and no withdrawals
are made, how much interest will be earned in one year? (4 marks)

(d) The Treasurer of your company has determined that the company needs GHC30,000 per
week to meet its cash requirement. Surplus funds can be invested in Treasury bills which
yield 15% per annum.

It was further noted that, it will cost GHC20 in administrative cost each time you convert
Treasury bills for cash. Assume 52 weeks in a year.

You are required to

Compute the optimum amount of Treasury bills you need to sell each time you need cash.
(4 marks)

(Total: 20 marks)

QUESTION 2

(a) Two companies, A Ltd and B Ltd, listed on the Ghana Stock Exchange have statements of
financial position as set out below:
A Ltd B Ltd
GHC GHC
Equity Shares 1,000,000 200,000
Income Surplus 400,000 200,000
Long-Term Loan 200,000 200,000
1,600,000 600,000

ICAGP3.41112 Page 1 of 4
 Non-current Assets 1,200,000 400,000
Net Current Assets 400,000 200,000
1,600,000 600,000

Other information concerning the two companies is as follows:

A Ltd B Ltd
Number of Equity shares issued and outstanding 1,100,000 500,000
Maintainable annual profit after-tax attributable
to equity GHC240,000 GHC150,000
Current market price of equity shares GHC2.40 GHC2.70
Current Earning Per Share (EPS) 24GP 30GP
Price-Earning (PE) ratio 10 9

A is proposing to take over B by means of an issue of its own shares in exchange for those
of B and has to decide on the terms of its offer.

What offer should the directors of A make to the shareholders of B based on the following
valuation methods:

(i) Net Asset Value (8 marks)

(ii) Market Value (8 marks)

(b) Stay Blessed Company Ltd plans to borrow GHC100,000 for a 90 day period from S & T
Finance Company. Stay Blessed would repay the principal amount plus GHC5,000 interest
at maturity.

Calculate the Annual Percentage Rate of the credit to Stay Blessed Company Ltd.
(4 marks)

(Total: 20 marks)

QUESTION 3

(a) Ohia Limited has annual credit sales of GHC5 million and cost of sales of GHC1.8 million.
The company’s current assets consist of inventory and trade receivables. Current liabilities
consist of accounts payables and an overdraft facility with an average interest rate of 10%
per annum. The company gives 60 days credit to its customers and is allowed an average of
30 days credit by trade suppliers. The company has an operating cycle of 90 days.

Other relevant information:

Current ratio of Ohia Ltd 1.5:1
Cost of long term finance to Ohia Ltd is 12% per annum

ICAGP3.41112 Page 2 of 4
Required:

Calculate the,

(i) size of the overdraft of Ohia Ltd (4 marks)

(ii) net working capital of the company (3 marks)
(iii) total cost of financing its current assets (3 marks)

(b) Moon Ltd has 5 million shares outstanding at GHC30 each, 2 million preference shares
trading at GHC20 each and 2000 bonds trading at GHC500 each.

Required:

(i) Calculate the capital structure of the company. (3 marks)

(ii) How much must the firm earn annually in order to satisfy its three classes of providers of
funds if the equity holders require 25% return on capital employed, dividend rate on
preference shares is 20% and the coupon rate on the bonds is 15%. In this economy, interest
paid on debt is tax deductible. Corporate tax rate is 25%. (5 marks)

(c) Differentiate between Policy Lending Rate and Base Lending Rate. (2 marks)

(Total: 20 marks)

QUESTION 4

Towards the end of 2009, several Ghanaian banks made right issues (privileges subscriptions) to
their shareholders to buy additional shares. One bank’s offer opened on September 28 and closed
on October 23. It expected to sell 137,376,090 additional shares at GHC0.60 each.

Suppose the bank had previously issued 274,752,180 shares to shareholders which were selling at
GHC0.75 each during this period.

Required:

(a) If shareholder Omega received one right, how many shares did Omega have prior to the
rights issue? (2 marks)

(b) Omega is interested in the offer. Do you think she exercised her right on October 15? Why
or why not? (2 marks)

ICAGP3.41112 Page 3 of 4
(c) Mr. Alpha was not a shareholder and so he received no rights. Alpha wanted to buy shares
at the exercise price of GHC0.60 each however. How did he go about achieving his
objective? (3 marks)
(d) If the additional money raised is invested to earn a fair return, how much did Alpha
eventually pay for each share if he eventually bought 3 shares? (6 marks)
(e) Shareholder Beta owned 10% of the shares of the bank prior to the rights issue. If she did
not exercise her rights, what proportion of the bank does she now own? (3 marks)
(f) What happened to the difference between the proportion in (e) and her original 10%?
(4 marks)
(Total: 20 marks)

QUESTION 5

(a) (i) Identify the drawbacks of hedging exchange rate risk by using a swap agreement.
(4 marks)
(ii) Discuss the ways in which international capital investment decisions can be
distinguished from domestic capital investment decisions. (4 marks)

(b) Nsuro Limited is considering a bid for the acquisition of Staycool Limited. Both companies
are listed on the stock market and are in the same industry. The financial data on Staycool
Limited which is soon to pay its annual dividend is as follows:

Number of ordinary shares 10 million

Market price per share GHC4.20
Earnings per share GHC0.50
Dividend per share 1 year ago GHC0.25
Dividend per share 2 years ago GHC0.20
Proposed payout ratio 45%

Additional financial information:

Average price-earnings ratio 12
Equity beta 1.5
Risk free rate of return 5%
Return on the market 11%

Required:

Calculate the value to be placed on the shares of Staycool Ltd prior to the takeover using the
following methods:

(i) Dividend growth model (6 marks)

(ii) Price-earnings ratio method (6 marks)
(Total: 20 marks)

ICAGP3.41112 Page 4 of 4
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

SOLUTION 1

(a) Disadvantages of listing

(i) Time and cost spent preparing a floatation

- Management time and effort for at least 6 months processing the necessary
documents to meet floatation requirements
- Consultants fee to be paid for floatation documentation

(ii) Cost of maintaining a listing

- Annual fees paid to the stock exchange
- Cost of communicating to investors

(iii) Satisfying needs of shareholders

- Income or Capital growth

(iv) Accountability and lack of secrecy

- Directors who may not be part of the initial team brought on board
- Public interest and other regulatory disclosures

(v) Risk of takeover

- Unsatisfactory performance might lead to a takeover by a hostile bidder
leading to a loss of family business.

EXTRA
Different culture

(b) Advantages of Listing

(1) Immediate source of long term capital for the business. This will enable the
company pursue growth and reduce gearing levels.

(2) Gives company ongoing source of capital opportunity to issue new shares in
the future or to issue listed debt giving the company flexibility in its financing
options

(3) Easier Acquisition Opportunity

Able to issue shares as a consideration when making an acquisition

(4) Image Advantage

Credibility with suppliers and customers. Able to negotiate favourable terms
with bankers

(5) Share Inventive Schemes

Easier to implement motivating schemes for both directors ad employees

Page 1 of 6
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

(6) Personal Factors

Will be an honour to be a director of a listed company

(c) Interest = Effective annual rate x principal

= 0.06168 x 2000 = GHC123.26

Monthly Compounding is irrelevant when the effective rate is known.

_________
(d) Optimal sale = 2xDxT
C
D = 30,000 x 52 weeks = GHC1,560,000
T = GHC20
I = 15%

________________
2 x 1,560,000 x 20 = GHC20,396
0.15

SOLUTION 2

(a) (i) Net Asset Value (NAV)

NAV Value attributable to equity

Number of equity issued and outstanding

NAV for A = 1,400,000 = GHC1.40

1,000,000

NAV for B = 550,000 = GHC1.10

500,000
A Ltd is to issue 110 of its shares in exchange for every 140 of those in B Ltd.
To acquire the whole of the issued share capital of B Ltd, A Ltd should issue
500,000 x 110 = 392,857 new shares
140

(ii) Market Value

The current market price of A Ltd’s shares is GHC2.40 and of B Ltd’s shares is
GHC2.70.
To maintain the market value of any individual’s holding, A Ltd should issue 9 new
shares for each 8 of B Ltd’s shares (270 for 240). The total number to be issued is
500,000 x 9 = 562,000 new shares
8

Page 2 of 6
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

(b) APR = (1 + r/m)m – 1

Where: APR is Annual Percentage Rate
r is the nominal rate of interest per year
m is the number of compounding periods in a year (m = 1/TIME). Assume
360 days in a year

Now r = Interest (I) x 1

Principal (P) Time (T)
Given Interest = GHC5,000,
Principal = GHC100,000
Time = 90/260

=> r = GHC5,000 x 1/90/360

GHC100,000
= 0.2 or 20%

=> APR = (1 + 0.2/4)4 – 1

= 21.55%

SOLUTION 3

(a) i. Calculation of size of overdraft

Inventory Period = Operating Cycle + Payables Period – Receivables Period
= 90 + 30 – 60 = 60 days

Inventory = 60 x GHC1,800,000 = GHC295,890

365

Accounts Receivable 60 x GHC5,000,000 = GHC821,918

365

Current Assets = GHC295,890 + 821,918 = GHC1,117,808

Current Liabilities = Current Asset = 1,117,808 = GHC745,205
Current Ratio 1.50

Accounts Payable = 30 x GHC1,800,000 = GHC147,945

365

:. Overdraft = GHC745,205 – 147,.945 = GHC597,260

ii. Net Working Capital = Current Asset – Current Liabilities

= GHC1,117,808 – 745,205
= GHC375,603
Page 3 of 6
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

iii. Total cost of Financing Current Assets: GHC

Short term financing cost 10% @ 597,260 = 59,726
Long term financing cost 12% @ 372,603 = 44,712
104,438

(b) Capital Structure: GHC million

i. Equity shares 5,000,000 @ GHC30 = 150
Preference shares 2,000,000 @ GHC20 = 40
Bonds 2,000 @ GHC500 = 1
191

The capital structure of the company is in the proportion of 78.5%, 20.9% and
0.6% for equity, preference shares and bonds respectively.

ii. How much the firm should earn annually GHC million
Equity holders 25% x 150 = 37.5
Preference shares 20% x 40 = 8.0
Bonds (15% x GHC1m) (1 - .25) = 0.075
45.575

(c) Policy Lending rate refers to the rate at which Central bank will lend money to
Commercial Banks.

Base Lending Rate refers to the breakeven rate of Commercial Banks.

SOLUTION 4

(a) In Ghana, bank issued 137,376,090 rights (one right for one additional share)
Rights are issued in proportion to existing shares
Thus, the ratio of new shares to old = 137,376,090 = 2 existing shares
274,752,180

AA owned 2 shares

(b) No she would not have exercised on October 15. She should wait until October 23. If
on this date existing shares were selling above GHC0.60 then she should exercise. If
not she should just buy the shares on the market, if she still wanted (at less than
GHC0.60).

(c) BB would buy 3 rights and this will entitle him to pay GHC0.60 for each share.

Page 4 of 6
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

(d) BB has 3 shares and AA has three shares. All shares have equal value. AA’s
investment in the bank is 2 shares at GHC0.70 plus one share at 0.60 = 2 x 0.75 + 0.6
= GHC2.1.
BB’s 3 shares are also worth GHC2.1
:. BB paid GHC2.1/3 = GHC0.70 per share
This includes the cost of buying the rights.

(e) CC owned 10% of 274,752,180 = 2,747,521.8 shares

New total shares = 274,752,180 + 137,376,090
= 412,128,270 shares

CC proportion = 2,747,521.8 = 6.67%

412,128,270

(f) She must have sold the rights she received but did not exercise. The value of these
rights that she received accounts for the 10% - 6.67% = 3.23%

SOLUTION 5

(a) i. The drawbacks of hedging include the following points

1. A company may find it difficult to find an appropriate swap partner which has
equal but opposite requirements to itself.

2. Once engaged in a swap agreement it is not possible to benefit from favourable

movements in the exchange rate.

3. The swap partner has to be vetted s as to reduce the possibility of counterparty

default.

ii. In distinguishing between international and domestic capital investment

decision, the following points should be considered:

1. Difficulties in valuing investments by the parent company.

2. The problem of exchange rates, e.g. estimation difficulties in future exchange

rates

3. Taxation due to different tax regimes

4. Restrictions on the repatriation of funds e.g. exchange controls

Page 5 of 6
 SOLUTION FINANCIAL MANAGEMENT NOV 2012

5. International investment decisions and risk e.g. political risk, exchange rate
and interest rate risk.

(b) (i) Dividend growth model

Po = Do (i + g)
R–g

Earnings per share of Staycool = GHC0.50

Proposed payout ratio = 45%
Proposed dividend 0.45 x 0.50 = GH0.225
Growth = di 1/n – 1 = 0.225 - 1 = 6%
do 0.20

Cost of Equity using CAMP = 5 + 1.5 (11 – 5) = 14%

Value per share = 0.225 (1.06) = 0.2385 = GHC2.98

0.14 – 0.06 0.08

Value of Staycool Ltd = GHC2.98 x 10m = GHC29.8m

ii. Price Earning Valuation Method:

Earnings per share = GHC0.50
Avg. P/E ratio = 12
Number of shares = 10m
Value per share = EPS x P/E ratio
GHC0.50 x 12 = GHC6.00

Value of Staycool Ltd = GHC6.00 x 10m = GHC60m

Page 6 of 6
 COST AND MANAGEMENT ACCOUNTING
QUESTION 1

MAX Construction Limited was contracted to construct a six-unit classroom block at Kaase on
the 1st of January 2012. The cost of the project was GH¢250,000 with a provision of 10% for
contingency. The contractor was also entitled to Advance Mobilization of 30% of the Contract
Sum upon submission of Performance Bond.

The following transactions took place during the year 2012.

(i) Material sent to site:
GH¢
Sand 10,000
Stones 20,000
Blocks 22,000
Cement 30,000
Others 12,000

(ii) Direct Labour Cost 25,000

Direct Expenses 10,000

(iii) Equipment sent to site was valued at GH¢180,000.

(iv) The consultant for the project issued a certificate valued at GH¢200,000.

Information as at 31/12/2012:
GH¢
(i) Materials on site 20,000

(ii) Work completed but not certified 15,000

Overhead is charged at 25% of Prime Cost.

The Site Engineer had also estimated the following costs to get the project completed.

Direct materials GH¢12,000, Direct Labour GH¢10,000 and Overhead of 25% on Prime Cost.
Additional Information:

(i) Depreciation is at 10% of cost.

(ii) The company recognizes stage of completion with reference to the proportion costs
incurred to date bears with total estimated costs to complete the project.

(iii) Retention is 10% of Value of certificate.

Required:

(i) Prepare a statement to show the Profit to be transferred to Income Statements for the year
ended 2012.
(8 marks)

(ii) Calculate the value of work-in-progress to be included in the Statement of Financial

Position of the Company as at 31/12/12.
(4 marks)

(iii) List and explain four (4) conditions that should prevail to make the operation of the Just-
in-Time Inventory Management system successful.
(8 marks)

(Total: 20 marks)
QUESTION 2

JACK manufactures a special product, with a standard cost of GH¢80 made up as follows:
GH¢
Direct materials 15sq meters @ GH¢3 per sq. meter 45.00
Direct Labour (5 hrs @ GH¢4/hr) 20.00
Variable Overheads (5 hrs @ GH¢2/hr) 10.00
Fixed Overheads (5hrs @ GH¢1/hr) 5.00
80.00
 The standard selling price of the product is GH¢100
 The monthly budget projects production and sales of 1,000 units.

Actual figures for the month of July are as follows:

 Sales 1,200 units at GH¢102 each

 Production 1,400 units
 Direct Material 22,000 sq. meters @ GH¢4 per sq. meter
 Direct Wages 6,800 hours at GH¢5 per hour
 Variable Overheads GH¢11,000
 Fixed Overheads GH¢6,000

Required:

(a) Calculate the following variances.

(i) Material Price Variance

(ii) Material Usage Variance
(iii) Labour Rate Variance
(iv) Labour Efficiency Variance
(v) Total Variable Overhead Variance
(vi) Fixed Overhead Efficiency Variance
(vii) Fixed Overhead Expenditure Variance
(viii) Fixed Overhead Capacity Variance
(ix) Sales Margin Price Variance
(15 marks)

(b) Based on the variances calculated in (a) above, determine the actual profit for the period.
(5 marks)
(Total: 20 marks)
QUESTION 3

(a) PTM operates two segments. The following is a summary of performance and financial
position as at 31/12/11.
A B
GH¢ GH¢

Sales 240,000 420,000

Cost of Sales 120,000 220,000
Other Expenses 60,000 1,010,000
Fixed Assets 1,010,00 2,300,000
Current Assets 300,000 800,000
Current Liabilities 250,000 550,000

The company intends to improve its capacity by the disposal of obsolete assets and
replacing them with modern ones.

Segment A:
An asset with written down value of GH¢ 30,000 will be replaced with one costing
GH¢75,000 to increase profit by GH¢20,000. The old asset contributed 8% of the 2011
profit.

Segment B:
An asset with written down value of GH¢120,000 which contributed 10% to 2011 profit
is to be replaced with one costing GH¢180,000 that will increase profit by GH¢45,000.

Required:

(a) i. If Return On Capital Employed (ROCE) is used to evaluate the performance of

managers, will the managers approve of the proposal?
(8 marks)

ii. What will be the position if Residual Income is used?

Note: Cost of capital is 8%.
(6 marks)

(b) Discuss three (3) factors in Budgetary Control system that will de-motivate staff?
(6 marks)

(Total: 20 marks)
QUESTION 4

BBQ Co. Ltd. is a manufacturer of glass bottles which has been affected by competition from
plastic bottles and currently operating below capacity. The data below relate to BBQ Co. Ltd.
which makes and sells one product (glass bottles):

January February March

(Units) (Units) (Units)
Sales 5,000 7,000 4,000
Production 9,000 3,000 4,000

GH¢ GH¢ GH¢

Selling price per Unit 100 100 100
Variable production cost per Unit 60 60 60
Fixed production overhead incurred 120,000 120,000 120,000
Fixed production overhead cost per unit,
being the predetermined overhead
absorption rate 15 15 15

Selling & Distribution cost (fixed) 50,000 50,000 50,000

Required:

(a) Prepare comparative profit statements for each month using:

(i) Absorption costing

(ii) Marginal costing
(12 arks)

(b) Explain two justifications each for using both variable and absorption costing.
(8 marks)

(Total: 20 marks)
QUESTION 5

(a) Discuss four (4) principles that should guide the Accountant in the establishment of a
Cost Accounting System for a medium sized Manufacturing Company.
(8 marks)

(b) Explain the following concepts as used in Inventory Management System.

(i) Economic Order Quantity. (2 marks)

(ii) Maximum Stock level. (2 marks)

(c) The following data was extracted from the books of Amantia Ltd. on one of the major
materials used in production.

Items received during the month of February 2013.

Date Qty (Unit) Unit Cost GH¢

02/02/13 1,000 12
06/02/13 800 14
12/02/13 1,200 18
20/02/13 700 16

Items issued out for production during the month:

Date Qty (Units)

10/02/13 650
14/02/13 1,300

Required:

Calculate the total cost of materials sent to Work-In-Progress Account using the
Weighted Average Method of inventory valuation.
(8 marks)

(Total: 20 marks)
 FINANCIAL MANAGEMENT

QUESTION 1
(a) (i) Briefly explain the term shareholder value maximization and provide THREE
reasons why it is considered more appropriate than profit maximization.
(4 marks)

(ii) Identify four non-financial goals that can be pursued by a company.

(4 marks)

(iii) Explain briefly why Preference shares are not popular as a source of finance for
Companies.
(2 marks)

(b) (i) Explain clearly the difference between an Interest Rate Swap and Currency Swap.

(4 marks)

(ii) ABC Bank Ltd. wishes to borrow on a fixed rate whereas XYZ Bank prefers a
floating rate.

ABC Bank can borrow on floating rate at Bank Lending Rate (BLR) + 4.5% or
fixed rate at 20% per annum.

XYZ Bank can borrow on floating rate at BLR + 3.5% or fixed rate at 15% per
annum.
Required:

(ii) Demonstrate how they will use interest rate swap to their mutual benefits.
(ii) Compute the gain resulting from the swap arrangement.
(6 marks)
(Total: 20 marks)
QUESTION 2

(a) The management of “Rudi Bank”, a private indigenous financial institution with
speciality of granting credit facility to Oil and Gas industry players has decided to raise
funds through issue of shares to meet the minimum capitalization requirement set by
Bank of Ghana.

Required:
Briefly and clearly explain the various ways in which the bank can obtain a quotation for its
shares on the Ghana Stock Exchange.
(6 marks)
(b) Nhyira Limited makes an annual credit sales of GH¢4,700,000. Credit period was 30
days but as a result of poor credit administration, the average collection period has been
45 days with 1% sales resulting into bad debts which are normally written off.
A factor by name Quick Collection Ltd. is being considered to take up the administration
of the debts and trade credits on quarterly fees of 0.625% of credit sales. In this respect,
the company would save administrative costs of GH¢100,000 annually and the payment
is expected to be 30 days.

The factor would provide 80% of invoiced debts in advance at an interest rate of 3% per
quarter (base rate). The company can obtain overdraft facility to finance its debtors at a
rate of 2.5% over base rate.

Required:

Advise the company’s management on whether or not to accept the services of a factor.

(14 marks)

(Total: 20 marks)
QUESTION 3

(a) Give THREE (3) reasons why Net Present Value of Investment Appraisal is superior to
other methods of investment appraisal.
(3 marks)
(b) The demand for phone cards is about 600,000 units per annum. It was estimated that it
cost GH¢3 to keep one unit of the card in stock for one year.
The Finance Manager estimated that it will cost GH¢40 each time an order is to be
placed.

Required:
(i) Calculate the economic order quantity..
(ii) Calculate the total inventory cost per annum. (7 marks)

(c) Ama Serwaa is considering two different saving plans. The first plan would have her
deposit GH¢500 every six months, and she would receive interest at 7 percent annual
rate, compounded semi-annually. Under the second plan she would deposit GH¢1,000
every year with a rate of interest of 7.5 percent, compounded annually. The initial
deposit with Plan 1 would be to start six months from now and with Plan 2, one year
hence.

(i) What is the future (terminal) value of the first plan at the end of 10 years?

(5 marks)

(ii) What is the future (terminal) value of the second plan at the end of 10 years?

(5 marks)
(Total: 20 marks)
QUESTION 4

(a) RR has a market value of GH¢150 million, whiles MM has market value of GH¢350
million. MM has estimated that if it combines resources with RR, incremental revenue
and cost will be GH¢70 million and GH¢30 million per annum forever respectively. On
the basis of the above projections, MM makes an offer for the entire value of RR. MM’s
cost of Capital is 20%.

Required:

(i) What is the gain from this transaction? (2 marks)

(ii) If MM makes a cash offer of GH¢205 million for all the shares of RR, what is the cost of
this transaction.
(2 marks)

(iii) What is the Net Present Value of this transaction to MM? (3 marks)

(iv) If MM offered shares valued at GH¢320 million, what will be the cost of the share offer?
(2 marks)

(v) What is the Net Present Value of the share offer? (2 marks)

(vi) Outline two (2) reasons why shareholders of MM will insist on share offer instead of cash
offer.
(3 marks)

(b) PRG Ltd. expects to pay no dividend for the next two years. However, dividend for the
third year would be GH¢1 per share and the dividend is expected to grow 3% in year 4
and 6% in year 5 and 10% in year 6 and thereafter forever. If the required return for the
company is 20%, what is the current price for the shares?
(6 marks)
(Total: 20 marks)
QUESTION 5

Farfrae Co. Ltd., manufacturers agriculture chemicals and fertilizers. The company uses one
particular machine which has an operational life of three years and which costs GH¢20,000. The
machine’s maintenance and operational costs increased with its age and its residual value
decreased as set out below.

Year Outlay Operating Cost Residual Value

GH¢ GH¢ GH¢

0 (20,000) - -
1 - (4,000) 14,000
2 - (8,000) 10,000
3 - (10,000) 8,000

The Company’s cost of capital is 10%.

Required:

Using the Lowest Common Multiple (LCM) and the Equivalent Annual Cost Methods, calculate
the most economic option for the company to replace its machine every:

(i) one year

(ii) two years

(iii) three years

(Total: 20 marks)
 FINANCIAL REPORTING
QUESTION 1
(a) (i)
The IASBs’ Framework for the Preparation and Presentation of Financial Statements
requires financial statements to be prepared on the basis that they comply with certain
accounting concepts (underlying assumptions) such as:

1. Matching/Accruals
2. Prudence
3. Comparability
4. Materiality

Required:

Briefly explain the meaning of each of the above concepts/assumptions.

(4 marks)

(ii) For most entities, applying the appropriate concepts/assumptions in Accounting for
Inventories is an important element in preparing their financial statements.

Required:

Illustrate with examples how each of the concepts/assumptions in (i) above, may be applied to
Accounting for Inventories.
(6 marks)

(b) Adom Ltd. produces a palm oil processing machinery at a cost of GH¢25,200. It either
sells the machinery for cash of GH¢33,550 or leases it to rural communities on a three
year lease.

On 1 January, 2013, Adom Ltd. entered into a three-year non-cancellable lease with
Twifoman Community on the following terms:

(i) Lease rentals were GH¢11,200 payable annually in advance

(ii) Initial direct cost of GH¢16,800 was incurred in commission and legal fees and
were borne by Adom Ltd. This is to be charged to the income statement on a
systematic basis.
(iii) There is a guaranteed residual value of GH¢5,600.
(iv) The interest rate implicit in the lease with Twifoman Community was 18% per
annum.

On 1 January, 2013, Adom Ltd. entered into arrangement with Boadi Enterprise (BE). BE had
purchased a machinery from Adom Ltd. but having run into cash flow problems, BE arranged a
sale or lease back of the machine to Adom Ltd.
The arrangement was that BE should sell the machine to Adom Ltd. for GH¢24,956 and
immediately lease it back for 4 years at a rental of GH¢7,500 payable yearly in advance. At the
time of the sale, the book value of the machine was GH¢15,000 which was arrived at after the
calculation of depreciation on straight line basis. It was agreed that the machine should revert
back to Adom Ltd. at the end of the 4-year period when its scrap value was estimated to be nil.
The lease is non-cancellable and Adom Ltd. is reasonably confident that the lease payment will
be met. The interest rate implicit in the lease with BE was 14% (ignore taxation).

Required:

(i) In respect of the lease with Twifoman Community:

 Draft the entries that would appear in the income statement of Adom Ltd. for the year
ended 31 December, 2013.

 Draft the entries that will appear in the statement of financial position of Adom Ltd.
as at 31 December 2013 and 2014.

(ii) In respect of the transaction with BE, draft the journal entries to record the transaction in
the books of BE for the year ended 31 December, 2013.

Present value factors are:

End of year 14% 16% 18%

1 0.877 0.862 0.848
2 0.789 0.743 0.718
3 0.765 0.641 0.609
4 0.592 0.552 0.516
5 0.519 0.476 0.437
(14 marks)

(Total: 24 marks)
QUESTION 2

The summarized Statement of Financial Position of Adidome Ltd. and Akatsi Ltd. as at 31
December 2012 were as follows:
Adidome Akatsi
Ltd. Ltd.
GH¢ GH¢
Non-current Assets:
Property, Plant & Equipment 80,000 58,200
Investment 84,000 -
----------- ---------
164,000 58,200
----------- ---------

Current Assets:
Inventory 18,000 12,000
Trade & Other Receivables 62,700 21,100
Cash & Bank Balances 10,000 5,500
Current Account: Adidome Ltd. - 3,200
--------- --------
90,700 41,800
--------- --------
Total Assets 254,700 100,000

Equity & Liabilities

Current Liabilities
Trade & Other Payables 35,000 11,000
Current Accounts: Akatsi Ltd. 2,700 -
-------- --------
Total Liabilities 37,700 11,000
-------- --------
Equity Funds
Stated Capital 120,000 60,000
Income Surplus 56,000 16,000
Capital Surplus 41,000 13,000
---------- ---------
Total Equity Funds 217,000 89,000
---------- ---------
Total Liabilities & Equity 254,700 100,000

The following information is relevant:

(1) On 1 January 2010, Adidome Ltd. acquired 48,000 of the equity shares in Akatsi Ltd. for
GH¢84,000 cash when the balance on the income surplus of Akatsi Ltd. was GH¢8,000
whilst the balance on the capital surplus account was GH¢13,000.
(2) On the date of acquisition, one item of plant of Akatsi with a book value of GH¢4,000
had a fair value of GH¢6,000. The plant had a remaining economic life of four years.
The fair valuation had not been reflected in the separate statement of financial position of
Akatsi Ltd.

(3) During the year, Akatsi Ltd. sold goods to Adidome Ltd. at a mark-up of 25%. As at the
end of the year, the inventories of Adidome Ltd. included GH¢4,000 of goods from
Akatsi Ltd.

(4) A cheque for GH¢500 from Adidome Ltd. to Akatsi Ltd., sent before 31 December,
2012, was not received by the latter company until January 2013.

(5) An impairment review at 31 December 2012 revealed that the goodwill in respect of
Akatsi Ltd. had fallen in value over the year by GH¢500. By 1 January 2013, this good
would have already suffered impairments totaling GH¢ GH¢1,700.

(6) The stated capitals of Adidome Ltd. and Akatsi Ltd are made up of 120,000 and 60,000
issued ordinary shares respectively. The shares were issued at GH¢1.00 each.

(7) The group policy is to fair value non-controlling interest. The market price per share of
Akatsi on 1 January 2010 was GH¢1.40.

Required:

Prepare the Consolidated Statement of Financial Position of the Adidome Ltd. group as at
31 December 2012.
(15 marks)
QUESTION 3

Obeng, Ofori & Co. a firm of Chartered Accountants agreed to admit a new partner with effect
from 1st July 2013. The current partners of the firm and their Profit or Loss sharing ratios are as
follows:

Obeng - 3
Ofori - 3
Oko - 1

The new partner, Akoele has been offered one-eighth share of profits while the old partners
maintain their old profit sharing ratio. The partners do not receive interest on capital neither do
they receive salaries.

The following Assets of the firm are to be revalued as follows, following the admission of
Akoele:
GH¢
Land and Building 220,000
Fixtures and Fittings 80,000
Motor Vehicles 33,000
Investments 50,000
Trade and Other Receivables 60,000

Akoele is to introduce GH¢60,000 into the firm. The other partners are to introduce cash to
make up for any deficiencies in their Capital Accounts after adjusting for goodwill.

It was agreed that goodwill would be valued at the sum of three years’ purchase of profits
immediately preceding the date of admission.

The Profits for the previous five years are as follows:

GH¢
Year to 30/6/2008 12,000
Year to 30/6/2009 14,500
Year to 30/6/2010 15,500
Year to 30/6/2011 18,000
Year to 30/6/2012 22,500
The Statement of Financial Position of the firm as at 30th June, 2012 is as follows:

Non-current Assets: GH¢ GH¢

Land & Building 165,000
Fixtures & Fittings 82,000
Motor Vehicles 44,000
291,000
Investments 24,000
315,000
Current Assets:
Work in progress 50,000
Trade and Other Receivables 65,000
Bank 50,000
Cash 5,000 170,000
485,000
Capital Accounts:
Obeng 140,000
Ofori 135,000
Oko 75,000 350,000

Current Accounts:
Obeng 25,000
Ofori (20,000)
Oko 10,000 15,000

Current Liabilities:
Trade & Other Payables 120,000
485,000

Required:

(a) Calculate the value of goodwill as at 1st July, 2013.

(2 marks)
(b) Prepare the Revaluation Account.
(3 marks)
(c) Prepare a Statement of Financial Position as at 1st July, 2013.
(6 marks)
(d) Prepare the Partners’ Capital and Current Accounts in Columnar form.
(4 marks)
(Total: 15 marks)
QUESTION 4

(a) Supply Products Ltd. is a large paper manufacturing company. The company’s Finance
Director is working on the published accounts for the year ended 31st March 2013. The
Chief Accountant has prepared the following list of problems which will have to be
resolved before the statements can be finalized.

1. Events after the reporting date (IAS 10)

A fire broke out at the company’s Spincity factory on 4th April, 2013. This has destroyed
the factory’s administration block. Most of the costs incurred as a result of this fire were
uninsured. A major customer went into liquidation on 27th April, 2013. The customer’s
balance at 31st March 2010 remains unpaid. The receiver has intimated that unsecured
payables will receive very little compensation, if any.

2. Possible Investment Property (IAS 40)

The company decided to take advantage of the down turn in property prices and
purchased a new office building at East Legon. This was purchased with the intention of
the building being resold at a profit within five years. In the meantime, the company is
using the property to house the administrative staff from the Spincity factory until such
time as their own offices can be repaired. It is anticipated that this will take at least nine
months. The Managing Director has suggested that the building should not be
depreciated.
3. Possible Development Expenditure (IAS 38)
The company paid the Engineering Department at N’asem University a large sum of
money to design a new pulping process which will enable the use of cheaper raw
materials. This process has been successfully tested in the University’s laboratories and
is almost certain to be introduced as Supper Products Ltd.’s pulping plant within the next
few months.
The company paid a substantial amount to the University’s Biology Department to
develop a new tree species of tree which could grow more quickly and therefore enable
the company’s forest to produce more wood for paper manufacturing. The project met
with some success in that a new tree was developed. Unfortunately, it was prone to
disease and the cost of the chemical sprays needed to keep the wood healthy rendered the
tree uneconomical.

4. Possible Contingent Liabilities (IAS 37)

One of the company’s employees was injured during the year. He had been operating a
piece of machinery which had been known to have a faulty guard. The company’s
lawyers have advised that the employees has a very strong case, but will be unable to
estimate the likely financial damages until further medical evidence becomes available.

One of the company’s customers is claiming compensation for the losses sustained as a
result of a delayed delivery. The customer had ordered a batch of cut sheet with the
 intention of producing leaflets to promote a special offer. There was a delay in supplying
the paper and the leaflets could not be prepared in time. The company’s lawyers have
advised that there was no specific agreement to supply the goods in time for this
promotion and furthermore, that it would be almost impossible to attribute the failure of
the special offer to the delay in the supply of the paper.
Required:
Explain how each of these matters should be dealt with in the published accounts for the year
ended 31st March, 2013 in the light of the International Financial Reporting Standards referred to
above. You should assume that the amounts involved are material in each case.
(10 marks)
(b) Progress Ltd. sells jewellery through stores in retail shopping centres throughout Ghana.
In the last three years, it has experienced declining turnover and profitability and
Management is wondering if this is related to the industry as a whole. It has engaged a
consultant who produced average ratios of many businesses. Below are the ratios that
have been provided by the consultant for the jewellery business sector based on year end
of 31st December 2012.
Return on Capital employed 16.8%
Net assets to Turnover 1.4 times
Gross profit margin 35%
Operating profit margin 12%
Current ratio 1.25:1
Average Inventory turnover rate 3 times
Trade payables payment period 64 days
Debt to equity 38%

The Financial Statements of Progress Ltd. For the year ended 31st December 2012 are:

INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2012

GH¢ GH¢
000 000
Revenue 168,000
Opening inventory 24,900
Purchases 131,700
156,600
Closing inventory 30,600 126,000
Gross profit 42,000
Operating costs (29,400)
Finance costs (2,400)
Profit before tax 10,200
Income tax 3,000
Profit for the year 7,200
Statement of Financial Position as at 31 December 2012

GH¢ GH¢
Non-current assets:
Property and shop fittings 76,800
Deferr4ed development expenditure 15,000
91,800
Current assets:
Inventories 30,600
Bank 3,000 33,600
125,400
Equity and liabilities:
Sated Capital 45,000
Capital surplus (Revaluations Surplus) 9,000
Income surplus 25,800
79,800

Non-current liabilities :
20% Loan notes 24,000

Current liabilities:
Trade payables 16,200
Current tax payable 5,400 21,600

Equity & liabilities 125,400

(i) Stated Capital is made up of 45,000 Ordinary Shares of no par value issued at a
consideration of GH¢1000 per share.

(ii) The deferred development expenditure is in respect of an investment in a process to

manufacture artificial precious gem for future sale by Progress Ltd in the retail jewellery
market.

Required:

(a) Prepare for Progress Ltd. equivalent ratios that have been provided by the consultant.

(8 marks)

(b) Assess the financial and operating performance of Progress Ltd. using the consultant’s
ratios as benchmarks.
(8 marks)

(Total: 26 marks)
QUESTION 5

The following list of account balances relates to Ankonam Ltd. at 31st March, 2011.

GH¢ GH¢
‘000 ‘000

Sales revenue (note a) 716,900

Cost of sales 370,100
Distribution costs 57,400
Administrative expenses 30,000
Lease rentals (note b) 40,000
Loan (note interest paid) 4,000
Dividend paid 24,000
Property at cost (note c) 400,000
Plant and equipment cost 309,600
Depreciation 1st April 2010 – plant and equipment 69,600
Development expenditure (note d) 60,000
Profit and disposal of non-current assets (note c) 90,000
Trade accounts receivable 110,000
Inventories: 31st March 2011 56,480
Cash and bank 21,320
Trade accounts payable 58,800
Taxation: over provision in the year to 31st March 2010 4,400
Stated Capital 300,000
8% loan note (issued in 2009) 100,000
Retained earnings 1at April 2010 143,200
------------- ------------
1,482,900 1,482,900

The following notes are relevant:

(a) Included in sales revenue is GH¢54 million, which relates to the sales made to customers
under sale or return agreements. The expiry date for the return of these goods is 30th
April, 2011. Ankonam Ltd. has charged a mark-up of 20% on cost for the sales.

(b) A lease rental of GH¢40 million was paid on 1st April, 2010. It is the first of five equal
annual payments in advance of the rental of an item of equipment that has a cash
purchase price of GH¢160 million. The auditors have advised that this is a finance lease
and have calculated the implicit interest rate in the lease as 12% per annum. Leased
assets should be depreciated on a straight-line basis over the life of the lease.

(c) On 1st April, 2010 Ankonam Ltd. acquired a new property at a cost of GH¢400 million.
For the purpose of calculating depreciation only, the assets have been separated into the
following elements:
 Separate asset Cost Life

GH¢’000
Land 100,000 freehold
Heating system 40,000 10 years
Lifts 60,000 15 years
Building 200,000 50 years

The depreciation of the elements of the property should be calculated on a straight-line

basis. The new property replaced an existing one that was sold on the same date for
GH¢190 million. It had cost GH¢100 million and had a carrying value of GH¢160
million at the date of sale. The profit on this property has been calculated on the original
cost. It had not been depreciated on the basis that the depreciation charge would not be
material. Plant and machinery is depreciated at 20% on the reducing balance basis.

(d) The figure for development expenditure in the list of account balances represents the
amounts deferred in previous years in respect of the development of a new product.
Unfortunately, during the current year, the government has introduced legislation which
effectively bans this type of product. As a consequent of this the project has been
abandoned. The directors of Ankonam Ltd. are of the opinion that writing off the
development expenditure, as opposed to its previous deferment, represents a change of
accounting policy and therefore wish to treat the write off as a prior period adjustment.

(a) A provision for income tax for the year to 31st March, 2011 of GH¢30 million is
required.

Required:

(a) Prepare the Statement of Comprehensive Income of Ankonam Ltd. for the year ended
31st March, 2011.

(b) Prepare a Statement of Financial Position as at 31 March, 2011; and

(c) Discuss the acceptability of the company’s proposed treatment of the deferred
development expenditure.

(20 marks)
 PUBLIC SECTOR ACCOUNTING

QUESTION 1

The following are the balances extracted from the Public Accounts on the Consolidated Fund for
the year ended 31 December 2012.

GH¢’000
Direct Tax 1,044,460
Compensation of Employees 808,672
Goods & Services 404,336
Non-Financial Assets 134,779
Indirect Tax 939,556
Grants 28,110
Interest Expenses 398,138
Social Benefits 238,882
Other Expenses 159,255
Other Revenue 50,928
National Health Insurance Levy 79,368
Depreciation and Amortization 20,524
Loan Repayments 3,056,000
Levies 27,184
Loans Received 4,245,150
Loan Recoveries 1,166
Other Payments 68,428
Cash and Bank Balances as at 1/1/2012 813,462

Required:

(a) Prepare Receipts and Payments of the Consolidated Fund for the year ended 31st
December 2012.

(b) Statement of Cash and Bank balances at the beginning and end of year ended 31st
December 2012.

(c) State the five (5) components of the financial statements of the Public Accounts of the
Consolidated Fund.
 (20 marks)
QUESTION 2

(a) Source documents are original documents for processing financial transactions and serve
as objective evidence of transactions.

Required:

As the Accountant of an MDA, mention five (5) source documents you will require to process
payment for the construction of a two classroom block for Donkokrom JSS.

(5 marks)

(b) While the roles and responsibilities of the public and the private sector partners differ in
individual partnership initiatives, the Public-Private –Partnership agreements may be
achieved under various forms.

Required:

Briefly explain the underlisted common forms of Public-Private-Partnership (PPP) in the

provision of infrastructure in the Public Sector:

(i) Operation and Maintenance

(ii) Build-Operate-Transfer (BOT)
(iii) Build-Transfer-Operate (BTO)
(iv) Build-Own-Operate (BOO)
(v) Concession
(10 marks)

(c) The doctrine of Due Process is an assurance that there is compliance with the
procurement law by all parties to Government contracts.

Required:

State five (5) benefits of Due Process in public procurement.

(5 marks)

(Total: 20 marks)
QUESTION 3

(a) The Annual Estimate is prepared in accordance with the budget circular received from
the Minister of Finance setting out the policy to be followed and the date for its
submission.

Required:

State and explain any five important budgetary policy objectives of government which the
preparation of the annual estimate helps to achieve.
(5 marks)

(b) Briefly explain two (2) roles each of the following Institutions in public financial
management:

(i) Cabinet
(ii) Public Accounts Committee
(iii) Heads of MDAs
(6 marks)
(c)
Section 30(i) of the Audit Service Act 2000 (Act 584) requires all Institutions subject to
Audit by the Auditor General, including MDA and MMDAs to set up Audit Report
Implementations Committees (ARIC).
List four (4) roles and responsibilities of the Committee.
(4 marks)

(d)
A Local Government Unit has planned to invest in a developmental project.

Required:

Outline Five (5) factors that the Unit should take into consideration before investing in the
project.
(5 marks)
QUESTION 4
a)
A government Agency has permission from the Office of the President to dispose of some store
items and vehicles by public auctions.
Required:
Enumerate five (5) procedures required to be followed for the disposal of the Assets.
(5 marks)
b)
The power to tax, borrow and create money to meet the aspiration of the Ghanaian public and to
raise their standard of living is based on the sovereign authority of the state.
Required:
State five (5) factors which the Government takes into consideration before borrowing.
(5 marks)
c)
The Auditor General or any person appointed by him to Audit the accounts of statutory
corporations shall draw attention to certain financial information in accordance with applicable
statutory provisions.

Required:

Identify five (5) financial information which the Auditor General is required by law to express
his opinion on, in the audit of statutory corporations.
(5 marks)
d)
Cash control relates to the co-ordinated actions which have to be taken by each and every MDA
in order to prevent cash losses and misuse.

Required:

State five (5) cash control measures that can be adopted by an MDA.
(5 marks)

(Total: 20 marks)
QUESTION 5

The following are the balances extracted from the Public Accounts on the Consolidated Fund of
the Government of Ghana for the year end 31st December, 2012.

GH¢

Other Payments 14,200

Fixed Assets 20,000
Inventory 25,008
Work-In-Progress 12,120
Sales of Fixed Assets 15,230
Shares and Other-equity Purchased 28,130
Advances Received 14,008
Advances Paid 583
Securities other than Sales 62,175
Goods and Services Costs 202,168
Compensation of Employees 381,420
Social Benefits 79,628
Interest Paid 318,511
Taxes 976,778
Grants 14,056
Other Revenues Received 25,464
Other Receipts 53,277
Domestic Loans Acquired 2,122,575
External Debts Paid 8,245
Domestic Loans Paid 1,519,756
Required:

a) Prepare Consolidated Fund Statement of Cash flow for the year ended 31st December 2012.

(10 marks)

b) What is the differences among Gross Debt, Total Liabilities and Net Debt as stated in the
Statement of Financial Position of the Government.
(6 marks)

c) State two importance of reporting the cost of services in the Revenue and Expenditure
Accounts of the Government of Ghana.
(4 marks)

(Total: 20 marks)
 THE INSTITUTE OF CHARTERED ACCOUNTANTS [GHANA]

COST AND MANAGEMENT ACCOUNTING

NOVECMBER 2013 SOLUTIONS

QUESTION 1
MAX CONSTRUCTION LTD.
GH¢ GH¢ GH¢
Statement of Profit:
Value of Contract 250,000

Less: Cost to date:

Materials 94,000
Direct Labour Cost 25,000
Direct Expenses 10,000
Depreciation 18,000
Overheads Head 32,250 179,250

Estimated Cost to Completion:

Direct Materials 12,000

Director Labour 10,000
Overheads 5,500 27,500

206,750
Expected Profit 43,250

Percentage of Completion

Cost to date = 179,250 x 100%

Cost to date + Cost to Complete 206,750
= 86.69%

Profit to be transferred

86.69 x 43,250 = GH¢37,493.43

100
 Closing WIP
Cost to date 179,250
Less mat on site 20,000 159,250

Add Profit taken 37,493

196,743
Less cash taken 180,000
16,743

OR
Work completed not certified 15,000
Add Retention 20,000
35,000
Less unrealized Profit 18,257
16,743
Note Unrealized Profit
Value of Certificate 200,000
Add Mat x WCNC 35,000
235,000
Less Cost to date 179,250
55,750
Less Profit taken 37,493
18,257
Just In Time: Conditions for successful operation
(i) Reliable Supply Source: The suppliers of materials and other inputs should have that
capacity to respond quickly and meet all orders.
(ii) Skilled Workforce: The employees should be skilled enough to handle the unit
production line to ensure defect free products.
(iii) Staff should be flexible to operate as many machines as possible. This will ensure
that where one operator is indisposed others can stand in for him.
(iv) The production line should be well set out to ensure smooth flow of that production
process.
QUESTION 2

A]
JACK LTD.
Calculation of variances
(i) Material price variance
(SP – AP) Actual Qty purchased
(3 – 4) 22,000 = 22,000 Adv.
(ii) Material usage variance
(Std Qty of Actual Prodn – Act Qty purchased) Std rate
{(15 x 1400) - 22,000} 3 = 3,000 Adv.

(iii) Wage rate variance

(Std rate – Actual rate) Act. Hrs.
(4-5) 6800 = 6,800 Adv.

(iv) Labour efficiency variance

Std of Act Prodn – Act labour) Std rate
{(5 x 1400) – 6,800} 4 = 800 Fav.

(v) Variable overhead efficiency variance

(Std hrs – actual hrs of actual prodn) VOAR
(7,000 – 6,800) 2 = 400 Fav
Variable overhead Expenditure Variance
Budgeted fixed Overhead – Actual Variance overhead
(6,800 x 2) – 11,000 = 2,600 Adv.

(vii) Fixed overhead expenditure variance

Budgeted Fixed Overheads – Actual Fixed hrs
(1,000 x 5) – 6,000 = 1,000 Adv
(viii) Fixed overhead efficiency
(Shrs of Act Prodn – Act lab hrs) FOAR
{(1400 x 5) - 6800} 1 = 200 Fav.
(ix) Fixed overhead capacity variance
(Act labour hrs – Budgeted lab hrs) FOAR
{6,800 – (1,000 x 5)} 1 = 1,800 Fav

(x) Sales margin price variance

(Act Sales Px – Std Price) Act Qty Sold
{(102 – 80) - 20} 1,200 = 2,400 Fav

Budgeted profit calculation

Std Margin x Budgeted Production
20 x 1,000 = 20,000

RECONCILIATION OF BUDGETED AND ACTUAL PROFIT

GH¢
Budgeted Profit 20,000
Adv Fav
 Sales Margin Px 2,400
 Sales Margin Volume 4,000
 Material Px 22,000
 Material Usage 3,000
 Wage rate 6,800
 Lab efficiency 800
 Var Ohd Exp 400
 Var Ohd Eff. 2,600
 Fixed Ohd Exp 1000
 Fixed Ohd Eff 200
 Fixed Ohd Capacity 1,800
32,800 12,200
 Net adverse variance (20,600)
Actual Profit/ (loss) ( 600)
QUESTION 3

A]
PMT LTD.
(i) Current ROCE:
A B
Profit = Sales 240,000 420,000
Cost 180,000 330,000
60,000 90,000
Asset Employed:
Fixed Assets 1,010,000 2,300,000
Net Current Assets 50,000 250,000
1,060,000 2,550,000
ROCI 60,000 90,000
1,060,000 2,550,000
5.66% 3.53%

A B
Proposal 60,000 - 4,800 + 20,000 90.000 – 9000 + 45,000
1,060,000 – 30,000 + 75,000 2,550,000 – 120,000 + 180,000
75,200 126,000
1,105,000 2,110,000
6.8% 4.83%

Proposal should be accepted:

(ii) Residual Income
A B
Profit 60,000 90,000
Cost of Capt 84,800 204,000
(24,800) (114,000)
Proposal

Profit 75,200 126,000

Cost of Capt 88,400 208,800
(13,200) (82,800)

Proposal should be accepted

B]

 Lack of participation
 High and unattainable targets
 Lack of support by management
 Use of Budgets only to punish
 Limited dissemination of budget information
QUESTION 4

A]
i. Absorption costing basis:
Jan (GH¢) Feb (GH¢) Mar (GH¢)

Opening stock at GH¢75/unit - 300,000 -

Production cost at GH¢75/unit 675,000 225,000 300,000
675,000 525,000 300,000

Less closing stock @ GH¢75/unit 300,000 - _

375,000 525,000 300,000

Under/ (over) recovery of fixed overheads (W1) (15,000) 75,000 60,000

Cost of Sales 360,000 600,000 360,000
Sales 500,000 700,000 400,000
Gross Profit 40,000 100,000 40,000
Less: Selling & Dist. Cost 50,000 50,000 50,000
Net Profit 90,000 50,000 (10,000)

WORKINS 1
(W1) Fixed overheads are recovered at GH¢15 per unit. The estimated activity level is therefore
8000 units (120,000/15 recovery rate). In January actual production is identical to estimated
activity, but in February actual production is 3000 units. Hence there is an under recovery of
GH¢75,000 (5000 units x GH¢15) in February.
i. Marginal Costing basis:

Jan (GH¢) Feb (GH¢) Mar (GH¢)

Opening stock at GH 60/unit - 240,000 -
Production cost at GH¢60/unit 540,000 180,000 240,000
540,000 420,000 240,000
Less closing stock @ GH¢60/unit 240,000 _ - -
Cost of sales 300,000 420,000 240,000

Sales 500,000 00,000 400,000

Contribution 200,000 280,000 160,000
Fixed Cost:
Production Overhead (120,000) (120,000) (120,000)
Less: Selling & Dist. Cost (50,000) (50,000) (50,000)
Net Profit 30,000 110,000 (10,000)

B]

Some Arguments in support of variable costing:

i. Variable costing provides more useful information for decision-making;-

The separation of fixed and variable costs helps to provide relevant information about cost for
making decisions.

ii. Variable costing removes from costing the effect of inventory charges:-

Where stock levels are likely to fluctuate significantly, profits may be distorted when they are
calculated in an absorption costing basis since the stock changes will significantly affect the
amount of fixed overheads allocated to an accounting period.

iii. Variable costing avoids fixed overheads being capitalized in unsalable stocks:-

In absorption costing, a portion of the fixed overheads incurred during the period will be
allocated as an expense because the surplus stocks. If these closing stocks cannot be disposed of,
the profit calculation for the current period will be misleading.
Some arguments in support of absorption costing:

i. Absorption costing does not understate the importance of fixed costs;-

It is argued that the use of an absorption costing system, by allocating costs to a product, ensures
that fixed costs will be covered. However, this argument is incorrect.

ii. Absorption costing avoids Fictions losses being reported.

QUESTION 5
A] Principles to consider when setting up a Cost Accounting System
 The system should be adopted to suit that general organization of that particular business.
The operating system should not be varied to suit an already designed accounting model.
 The technical aspect of the business should be carefully studied. It is the technical aspect that
will determine that accounting processes to be designed.
 The accountant should seek the support of the principal staff. Design and installation of an
accounting system is a team work to be able to link the key departments.
 The minimum amount of details in which records are to be compiled should be arranged.
 Records to be provided by foremen and other grades of workers should involve as little
clerical work as possible.
 Frequency, promptitude and regularity in the presentation of cost and statistics must be
arranged.

B]
i. Economic Order Quantity:
This is the quantity of items that should be bought such that total inventory cost will be at
minimum.
Inventory costs are (1) Cost of that inventory i.e. quantity times the cost price, ordering cost and
holding cost.
Any quantity less than or greater than the EOQ will increase total inventory cost.
EOQ = √ 2DCo
CH
iii. Maximum stock level
This is the level above which stocks should not normally be allowed to rise when the that order is
placed. In other word when consumption rate is low and lead time is short what will be the stock
when the consignment requested arrive?
Maximum SL = ROL – (min consumption x min LT) + ROQ
 THE INSTITUTE OF CHARTERED ACCOUNTANTS [GHANA]

FINANCIAL MANAGEMENT STRATEGY

NOVEMBER 2013 SOLUTIONS

QUESTION 1

(A)(i) Shareholder value maximization means maximizing the returns that investors expect in
exchange for becoming a shareholder. The wealth of shareholders is measured by regular
payment of dividend and appreciation in the share price.

Shareholders’ wealth maximization is preferred to profit maximization due to the

following:
i. It considers risk associated with cash flow.
ii. Cash flow is paid to shareholders not profit.
iii. It considers the timing of cash flows.
iv. Profit is value and can be manipulated.
(ii) Non-financial goals are:
i. Motivated staff
ii. Environmental friendliness
iii. Social responsibility
iv. Provision of quality goods or services
v. Growth.
(iii) Preference shares are not popular source of finance because:
i. They are less tax efficient
ii. They are riskier than debt since there is right to receive a preference dividend.
(B) i. Interest rate swap is an agreement between two parties to exchange fixed rate for floating
rate. Currency swap is an agreement between two parties to exchange financial
obligation in different currencies.
ii. Fixed Floating
ABC 20% BLR + 4.5%
XYZ 15% BLR + 3.5%
5 (1)
1. XYZ should borrow at fixed 15%
2. ABC should borrow at BLR + 4.5%
3. XYZ to assume the responsibility of floating rate: BLR + 4.5%
4. ABC to assume the responsibility of fixed rate of 15%.
5. Gain = 5% - 1% = 4%.
QUESTION 2

(a) A company may issue shares or obtain a quotation or listing on the stock exchange by the
following means/methods.

(i) Placement

Under this method, shares are issued at a fixed price to a number of institutional
investors. The issue is normally underwritten by the issuing company’s sponsor who is
usually a merchant bank. Essentially, this method carries a little risk and has low
transaction cost.

(ii) Offer for sale of fixed price

Under this method, shares are offered to the public with the help of a sponsoring bank at
a fixed price. The issue is also underwritten so that the company is guaranteed to receive
the finance it needs. There, any shares on offer which are not taken up will be bought by
the underwriters at an agreed price.

(iii) Offer for sale by tender

Here, the public is invited to bid for available shares at prices in excess of a minimum
decided by the issuing company. The price which ensures that all the shares on offer are
sold is called the striking prices. Available shares are than allocated on a prorate basis to
investors who have bidded at or above the minimum prices. Excess monies will then be
returned to unsuccessful bidders.

(iv) Intermediaries offer

Under this method, all member firms of the stock exchange can apply for shares which
they can subsequently pass onto their clients.

(B) NYIRA LIMTIED

Annual Credit Sales GH¢4,700,000 per annum

Average Credit Period 45 days

Interest rate per annum 3% @ 4 = 12%

Overdraft rate 12% + 2.5% = 14.5%

Annual Cost GH¢

45/365 @ GH¢4,700,000 @ 14.5% = 84,021

Bad Debt 1% @ GH¢4,700,000 = 47,000

131,021
Cost of the Factor
Credit sale finance 80% @ GH¢4,700,000 = GH¢3,760,000
Credit period = 30 days
20% of credit sales finance by O/D 20% @ Gh¢4.700,000 = GH¢940,000
Annual Cost GH¢
Factor’s finance = 30/365 @ 3,760,000 @ 12% = 37,085
Overdraft = 30/365 @ GH¢940,000 @ 14/5% = 11,203
48,288
Cost of factor service (0.625 @ 4) = 2.5% @ 4,700,000 117,500
Less Administration Cost (100,000)
Net cost/(benefit) of the factor 65,788

CONCLUSION
The factor option is cheaper by (131 021 – 65,788) = GH¢65,233. Management is
therefore advised to accept the services of the factor.
QUESTION 3

(a) Net Present Value (NPV) is generally superior because of the relationship between
future cash flows and shareholder wealth. If the company accepts a positive NPV
project then, at least in theory, shareholder wealth should rise by the same amount.
Using this criterion should align the decisions taken by management with the interest
of the shareholders.
NPV gives a sound basis for comparing alternative projects because it gives an
absolute value, with no ambiguity as to which is the better.
NPV works because it take account of the time value of money which is ignored by
many other methods. Payback and accounting rate of return make not allowance
whatsoever for the timing of receipts.
NPV can also make allowance for risk by building a risk premium into the discount
rate.
(b) Phone Cards – Economic Order Quantity
i. EOQ = 2 x DO
HC
D = 600,000 units
O = GH¢40
HC = GH¢3
EOQ = 2 x 600,000 x 40 = 4,000 units
3

ii. Total Inventory cost per annum

No. of order in a year = Demand

EOQ

= 600,000 = 150 times

4,000

Average Stock = EOQ + O

2
= 4,000 + O = 2,000 Units
2
Inventory cost GH¢

Ordinary cost 150 x 40 = 6,000

Holding cost 2,000 x 3 = 6,000

12,000
(c) Ama Serwaa

i. Plan 1 a = 500
r = 7% (0.07 = 0.035)
2

Fv = a C1 + r)n - 1
r

Fv = 500 (1+ 0.035)20 -1

0.035

= Fv = GH¢14,139.84

ii Plan 2

a = 1,000 r = 7.5% n = 10

Fv = 1.000 (I + r)n - 1
r

Fv = 1,000 (1+0.0750)10 – 1
0.075

Fv = GH¢14,147.09
QUESTION 4

(a) From transaction GH¢ million

Incremental Revenue 70
Cost 30

40

PV of the gain = 40
20

GH¢200

Cost of Transaction

i. Cost = Cash offer - PV RR

55 = 205 - 150

NPV of Transaction

ii. NPV = Gain - Cost

145 = 200 - 55

iii. Cost (of share offer) = 320 - 150 = 170

iv. NPV (of share offer) = 200 - 170 (30

v. 1. MM has no Cash
2. MM is pessimistic about the transaction.

1. Convince shareholders that the offer is not in their interest.

2. Demand high severance package
3. Counter off to the predator company.
4. Announce Dividend increase
5. Make the company look unattractive
6. Refer to merger commissioner of court.

(b) ORG Ltd.

Y1 Do
Y2 O
Y3 1
Y4 i(1 + 0.03) = 1.03
Y5 1.3(1 + 0.06) = 1.0918
Y6 1.0918 (1 + 0.10) = 1.20098

P6 = D6 = 1.20098 = 12.0098
r-g 0.20 – 0.10

Po = 0 + 0 + 1 + 1.03 + 1.0918 + 12.0098

3
(1.20) (1.20)4 (1.20)5 (1.20)6

= 0 + 0 + 0.5787 + 0.4967 + 0.4300 + 4.8264

= GH¢6.3407
QUESTION 5

FARFRAE COMPANY LTD

One year Cycle Cash flows

The Lowest Common Multiple = 6

Year Replacement Operating Residual Net Cash

Cost Cost Value Flow
GH¢ GH¢ GH¢ GH¢

0 (20,000) - - (20,000)
1 (20,000) (4,000) 14,000 (10,000)
2 (20,000) (4,000) 14,000 (10,000)
3 (20,000) (4,000) 14,000 (10,000)
4 (20,000) (4,000) 14,000 (10,000)
5 (20,000) (4,000) 14,000 (10,000)
6 (4,000) 14,000 10,000

Equivalent Annual Cost

One year replacement Cycle

0 1 NPV
Cost (20,000)

Operating Cost (4,000)

Residual value 14,000

(20,000) 10,000

DF @ 10% 1 0.909
___________ _______
PV (20,000) 9,090 (10,910)

EAC = (10,910) 1.909 = (12,002)

Two year Cycle Cash flows

Lowest Common Multiple

Year Replacement Operating Residual Net Cash

Cost Cost Value Flow
GH¢ GH¢ GH¢ GH¢

0 (20,000) - - (20,000)
1 - (4,000) - (4,000)
2 (20,000) (8,000) 10,000 (18,000)
3 - (4,000) - (4,000)
4 (20,000) (8,000) 10,000 (18,000)
5 - (4,000) - (4,000)
6 (8,000) 10,000 2,000

Year 2 Equivalent Annual Cost

0 1 2 NPV

Cost (20,00)

Operating cost (4,000) (8,000)

Scrap 10,000
_______ ______ _____
(20,000) (4,000) 2,000

DF @ 10% _________ 0.909 0.826 _______

(20,000) (3,636) 1,652 (21,984)

EAC = (21,984) = (12,671)

1.735
Three year Cycle Cash flows

Lowest Common Multiple

Year Replacement Operating Residual Net Cash

Cost Cost Value Flow
GH¢ GH¢ GH¢ GH¢

0 (20,000) - - (20,000)
1 - (4,000) - (4,000)
2 - (8,000) - (18,000)
3 (20,000) (10,000) 8,000 (22,000)
4 - (4,000) - (4,000)
5 - (8,000) - (8,000)
6 (10,000) 8,000 2,000

Equivalent Annual Cost

Discount all Cash Flows to get the present value of cost

0 1 2 3 NPV

Cost (20,00)

Operating cost (4,000) (8,000) (10,000)

Residual Value 8,000

_______ ______ _____ ______
(20,000) (4,000) 8,000 (2,000)

DF @ 10% 1 0.909 0.826 0.751 _______

(20,000) (3,636) 6,608 (1,502) (31,746)

EAC = (31,746) = (12,671)

2.48%
Year Discount 1st Year PV 2nd Year PV 3rd Year PV
Factor Cycle Cycle Cycle
10% GH¢ GH¢ GH¢ GH¢ GH¢ GH¢

0 1 (20,000) (20,000) (20,000) (20,000) (20,000) (20,000)

1 0.909 (10,000) (9,000) (4,000) (3,636) (4,000) (3,636)
2 0.826 (10,000) (8,260) (18,000) (14,868) (8,000) (6,608)
3 0.751 (10,000) 7,510 (4,000) (3,004) (22,000) (16,522)
4 0.683 (10,000) (6,830) (18,000) (12,294) (4,000) (2,732)
5 0.621 (10,000) (6,210) (4,000) (2,484) (8,000) (4,968)
6 0.565 10,000 5,560 2,000 1,130 (2,000) (1,130)
52,250 55,156 55,596

Decision

Farfrae should replace the asset every year.

 THE INSTITUTE OF CHARTERED ACCOUNTANTS [GHANA]

FINANCIAL REPORTING

NOVEMBER 2013 SOLUTIONS

QUESTION 1

(A) ACCOUNTING CONCEPTS

 Matching/Accruals
The accruals basis required transactions (or events) to be recognized when they occur
(rather than on a cash flow basis). Revenue is recognized when it is earned (rather than
when it is received) and expenses are recognized when they are incurred (i.e when the
entity has received the benefit from them), rather than when they are paid.

 Prudence
Prudence is used where there are elements of uncertainty surrounding transactions or
events. Prudence requires the exercise of a degree of caution when making judgments or
estimates under conditions of uncertainty. Thus when estimating the expected life of a
newly acquired asset, if we have past experience of the use of similar assets and they had
had lives of (say) between five and eight years, it would be prudent to use an estimated
life of five years for the new asset.

 Comparability
Comparability is fundamental to assessing the performance of an entity by using its
financial statements. Assessing the performance of an entity over time (trend analysis)
requires that the financial statements used have been prepared on a comparable
(consistent) basis. Generally this can be interpreted as using consistent accounting
policies (unless a change is required to show a fairer presentation). A similar principle is
relevant to comparing one entity with another; however it is more difficult to achieve
consistent accounting policies across entities.

 Materiality
Information is material if its omission or misstatement could influence (economic)
decisions of users based on the reported financial statements. Clearly an important aspect
of materiality is the (monetary) size of a transaction, but in addition the nature of the item
can also determine that it is material. For example the monetary results of a new activity
may be small, but reporting them could be material to any assessment of what it may
achieve in the future. Materiality is considered to be a threshold quality, meaning that
information should only be reported if it is considered material. Too much detailed (and
implicitly immaterial) reporting of (small) items may confuse or distract users.
(B) ACCOUNTING FOR INVENTORY

Accounting for inventory, by adjusting purchases for opening and closing inventories is a
classic example of the application of the accruals principle whereby revenues earned are
matched with costs incurred. Closing inventory is by definition an example of goods that
have been purchased, but not yet consumed. In other words the entity has not yet had the
‘benefit’ (i.e. the sales revenue they will generate) from the closing inventory; therefore
the cost of the closing inventory should not be charged to the current year’s income
statement.

At the year end, the value of an entity’s closing inventory is, by its nature, uncertain. In
the next accounting period it may be sold at a profit or loss. Accounting standards
require inventory to be valued at the lower of cost and net realizable value. This is the
application of prudence. If the inventory is expected to sell at a profit, the profit is
deferred (by valuing inventory at cost) until it is actually sold. However, if the goods are
expected to sell for a (net) loss, then that loss must be recognized immediately by valuing
the inventory as its net realizable value.

There are many acceptable ways of valuing inventory (e.g. Average Cost or FIFO). In
order to meet the requirement of comparability, an entity should decide on the most
appropriate valuation method for its inventory and then be consistent in the use of that
method. Any change in the method of valuing (or accounting for) inventory world break
the principle of comparability.

For most businesses inventories are a material item. An error (omission or misstatement)
in the value or treatment of inventory has the potential to affect decisions users may make
in relation to financial statements. Therefore (correctly) accounting for inventory is
material event. Conversely there are occasions where on the grounds of immateriality
certain ‘inventories’ are not (strictly) accounted for correctly. For example, at the year-
end a company may have an unused supply of stationery. Technically this is inventory,
but in most cases companies would charge this ‘inventory’ of stationary to the income
statement of the year in which it was purchased rather than show it as an asset.

Note: other suitable examples would be acceptable.

 Gross earnings allocated over the period of the lease are:

(GH¢39,200 million - GH¢33,550 = GH¢5650.4 million). Allocation based on finance

provided is as follows:

Period Net Cash Investment Rentals AV Cash Inv. Interest Net Cash Inv.
At start of period in Period at end of Period

2013 33,550 11,200 22,350 4,023 26,373

2014 26,373 11,200 15,173 2,731 17,904
2015 17,904 11,200 6,704 1,207 7,911
44,227

(i) Income statement for the year ended 31 December, 2003 (Extract)

GH¢
Turnover 33,550
Cost of Sale 25,200
Gross Profit 8,350

Interest receivable under finance lease 4,023

Direct lease expense (16,800/3) (5,600)

(ii) Statement of financial position (extract) as at 31 December.

2013 2014
GH¢ GH¢

Prepaid Expenses 11,200 5,600

Investment in Finance Lease
Current 9,352 11,620
Non-Current 17,021 6,284
26,373 17,904

(b) Given the value of the rentals compared to a reasonable estimate of the fair value, the
lease appears to be a finance lease. Although the seller/lesser appears to have made a
“profit” of GH¢9,956 million (GH¢24,956 million - GH¢15,000 million), the substance of
the arrangement is that the seller/lessee has taken out a loan of GH¢24,956 million on
which it will pay finance charges. The asset remain in the Statement of financial position
at GH¢15,000.
Relevant journal entries in the books of Saviour Enterprise (SE) are as below:

Dr Cr
GH¢ GH¢

Bank 24,956

Obligation under finance lease 24,956

Being sale of assets under leaseback agreement
and recognition of liability

Obligation under finance lease 5,056

Income statement (Finance charge) 2,443
Bank 7,500
Being rental paid to cover finance charge and to
Reduce obligation under Finance lease

Income statement 3,750

Accumulated Depreciation 3,750
Being the depreciation charged for the year (15,000/4 years)

Workings:
GH¢
‘Sale’ 24,956
Net book value (15,000)
Profit on sale 9,959
QUESTION 2

A]
ADIDOME GROUP LTD
STATEMENT OF FINANCIAL POSITION AS TAT 31 DECEMBER 2012

NON-CURRENT ASSETS GH¢

Property, Plant & Equipment (80,000 + 52,000 + 200,000 –1,500) 138,700
Intangibles (W3) 15,600
154,303
CURRENT ASSETS
Inventory (18,000 + 12,000 – 800) 29,200
Trade & Other Receivables (62,700 + 21,100) 83,800
Cash & Bank Balances (10,000 + 5,500 + 500) 16,000
129,000
Total Assets 283,300

EQUITY & LIABILITIES

Trade & Other Payables (35,000 + 11,000) 46,000
Total Liabilities 46,000

EQUITY FUNDS
Stated Capital 120,000
Income Surplus (W5) 58,800
Capital Surplus (W4) 41,000
Non-Controlling Interest 17,500
TOTAL EQUITY FUNDS 237,300
Total Liabilities & Equity 283,300
WORKINGS

(1) GROUP STRUCTURE

Adidome 80%
NCI 20%

(2) NET ASSETS OF AKATSI LTD.

At Reporting At Acquisition
Date
GH¢ GH¢

Stated Capital 60,000 60,000

Capital Surplus 13,000 13,000
Income Surplus 16,000 8,000
Revaluation Surplus 2,000 2,000
PURP (800) -
Additional account dep. (1,500) -
88,700 83,000
Post-acquisition = GH¢5,700

(3) GOODWILL GH¢

Cost of Investment 84,000
NCI at acquisition 16,800
100,800
Net Assets at acquisition (83,000)
178,000
Impairment (2,200)
15,600
(4) Consolidated Income Surplus
Adidome Ltd 56,000
Akatsi Ltd. (80% x 5,700 (W2) 4,560
Less: Goodwill impairment to date (80% x 2,200) (W3) (1,760)
58,800
(5) Non-Controlling Interest
Fair Value @ acquisition 16,800
Share Post-acquisition Profit (20% of 5,700) 1,140
Goodwill (20% x 2,200) (440)
17,500
B] ADJUSTMENTS – ELIMINATION OF UNREALIZED PROFITS

If one company holds inventories at the year-end which have been acquired from another
group Company, this will include a profit element that is unrealized from a group
perspective. Here Akatsi Ltd has sold goods to Adidome Ltd. As cost plus 25%. The
mark-up of 25% will only become realized when the goods are sold to a third party.
Therefore, if any intra-group inventory is still held at the year end, it must be eliminated
from the consolidated accounts. This will require an adjustment of GH¢800 (4,000 x
25/125) as follows:

Debit Akatsi Ltd’s Income Surplus (W2) GH¢800

Credit Consolidated Inventory GH¢800
As well as eliminating, the unrealized profit, this reduces inventory back to its original
cost to the group.

QUESTION 3

A] GOODWILL
Year to 30/6/2010 15,500
30/6/2011 18,000
30/6/2012 22,500
56,000

Obeng 3 - 24,000 (56,000 x 3/7)

Ofori 3 - 24,000 (56,000 x 3/2)
Oko 1 - 8,000 (56,000 x 1/7)

B] REVALUATION ACCOUNT

Land & Building 165,000 Land & Building 220,000

Furniture & Fittings 82,000 Furniture & Fittings 80,000
Motor Vehicles 44,000 Motor Vehicles 33,000
Investment 24,000 Investments 50,000
Debtors & Prepayments 65,000 Debtors & Prepayments 60,000
Obeng 27,000
Ofori 27,000
Oko 9,000 ______
443,000 443,000
 OBENG, OFORI & CO.
STATEMENT OF FINANCIAL POSITION AS AT 1ST JULY 2013

GH¢ GH¢

NON-CURRENT ASSETS
Land & Building 220,000
Furniture & Fittings 75,000
Motor Vehicle 30,000
325,000
Investments 60,000
385,000

CURRENT ASSETS
Work in Progress 50,000
Trade & Other Receivables 58,000
Bank (50 + 60 + 17) 127,000
Cash 5,000 240,000
625,000

CAPITAL & LIABILITIES

EQUITY

Obeng 167,000
Ofori 162,000
Oko 84,000
Akoele 53,000 466,000

CURRENT ACCOUNTS

Obeng 28,000
Ofori -
Oko 11,000
Akoele - 39,000

CURRENT LIABILITIES

Trade & Other Payables 120,000

625,000
 CAPITAL ACCOUNTS

Obeng Ofori Oko Akoele Obeng Ofori Oko Akoele

GH¢ GH¢ GH¢ GH¢ GH¢ GH¢ GH¢ GH¢

Bal c/d 167,00 162,000 84,000 53,000 Bal. 140,000 135,000 75,000 -

Cash 53,000

Reval. 27,000 27,000 9,000 -

______ ______ _____ ______ ______ ______ _____ _____
167,000 167,000 84,000 53,000 167,000 167,000 84,000 53,000

Bal. b/d 167,000 162,000 84,000 53,000

CURRENT ACCOUNTS

Bal. 20,000 Bal. 25,000 - 10,000 -

Goodwill 21,000 21,000 7,000 7,000 Goodwill 24,000 24,000 8,000 -

Bal. c/d 21,000 - 11,000 - Cash - 17,000 - 7,000

40,000 41,000 18,000 7,000 49,000 41,000 18,000 7,000

QUESTION 4

A]

(a) IAS 10 Events after the Reporting Date divides such events into two categories: adjusting
events and non-adjusting events. Adjusting events provide additional evidence of
conditions existing at the reporting date, while non-adjusting events relate to conditions
that did not exist at the reporting date.

The fire broke out on 4th April, after the reporting date on 31 March, so this is a non-
adjusting event. There is no evidence of a fire sincerely simmering at the reporting date
and exploding into life on 4th April; the evidence is that there was no fire at 31st March.
So the details of the fire should be disclosed in a note to the accounts, so that readers can
reach a proper understanding of the company’s affairs.

The major customer went into liquidation on 27th April. However the customer owed a
material balance on 31 March and it is now clear that this balance is not recoverable. The
liquidation is therefore an adjusting event, and supper Paper Products should write off the
bad debt in its financial statement prepared to 31st March, 2010.
(b) IAS 40 Investment Property states that properties which are held for their investments
potential should not be depreciated. However, IAS 40 defines an investment property
quire precisely, and specifically excludes a property owned and occupied by a company
for its own purposes. The new office building is owned by Super Paper products and it
occupied by the staff of Spintex factory, so it cannot be an IAS 40 investments property.
The managing director’s suggestion is therefore unacceptable, and the building must be
depreciated according to the company’s normal depreciation policy for buildings.

(c) IAS 38 Intangible Assets splits research and development expenditure into two
categories: research expenditure and development expenditure. Research expenditure
should be written off as incurred; development expenditure should be carried forward as
an asset if all of the following can be demonstrated:

(i) The technical feasibility of the project;

(ii) The intention to complete the project and used or sell it;
(iii) The ability to use or sell the item;
(iv) How the project will generate probable future economic benefits;
(v) The availability of adequate technical, financial and other resources to complete
the project.
(vi) The ability to measure the expenditure reliably.

The new puling process does seem to satisfy the conditions listed above, so the cost to
date should be carried forward in the statement of financial position as an intangible non-
current asset.

The attempt to develop a new species of tree definitely fails to satisfy the conditions
listed above. It is not commercially viable and may not overall recover its costs, so
expenditures on the project should be written off as incurred. There is no option to defer
any of the related costs to future accounting periods.

(d) IAS 37 Provision, Contingent Liabilities and contingent Assets defines a contingent
liability as:

(i) A possible obligation that arises from past events and shoes existence will be
confirmed only by the occurrence of one or more uncertain future evens not
wholly within the control o the enterprise; or

(ii) A present obligation that arises from past events but is not recognized because:

 It is not probable that a transfer of economic benefits will be required to settle

the obligation: or

 The amount of the obligation cannot be measured with sufficient reliability.

Unless the possibility of any transfer in settlement is remote, an enterprise is required by
IAS 37 to disclose for each class of contingent liability at the reporting date a brief
description of the nature of the contingent liability and where practicable.
(i) An estimate of its financial effect;
(ii) An indication of its uncertainties relating to the amount or timing of any outflow;
and
(iii) The possibility of any reimbursement.
A present obligation of the employee arising from his injuries exits, though we are
advised that it is not possible to quantify the liability. There are two possible course of
action in accounting for this inter. The lawyers could be pressed to make a prudent
estimate of the amount of damages, perhaps form preliminary medical reports, and this
estimate should then be provided in the account if the lawyers still insist that such an
estimate is impossible, there no point in guessing on a value to accrue. Instead the facts
should be disclosed as contingent liability in a note to the accounts, stating that no
liability has currently been recognized since a fair estimate is impossible. However, it is
important that this note is worded in such a way that no liability is admitted, for this
might prejudice the company’s potion in subsequent legal proceedings.
The second case is clearer cut. Lawyers have advised that there was no specific
agreement to supply the paper in time for the promotion, so any possible liability is
remote. IAS 37 does not require the disclosure of remote contingencies; they should be
completely ignored in the account if the probability of an outflow of economic resources
is remote.
B]
PROGRESS LTD.
SPECIFIED RATIOS FOR COMPARISON WITH THOSE OF THE CONSULTANTS

Progress Ltd. Consultant

1. Return on Capital Employed
(10,200 + 2,400)/ (76,800 + 24,000) x 100
12,600 x 100 2½% 16.8%
103,800

2. Net Asset Turnover

168,000
103,800 1.6 times 1.4 times

3. Gross Profit Margin

42,000 x 100
168,000 25% 35%

4. Operating Profit Margin

12,600 x 100
168,000 7½ 12%

5. Current Ratio
33,600
21,600 1.6:1 1.25:1

6. Average Inventory Turnover

(24,900 + 30,600)/2 = 27,750
126,000/27,750 4.5 times 3 times

7. Trade Payables Payment Period

16,200 x 365
131,700 45 days 64 days

8. Debt to Equity

24,000
79,800 30% 38%
(b) Assessment of Comparative Performance

Profitability
The primary measure of profitability is return on capital employed. Progress Ltd. is
ROCE of 12½% is significantly lower than the consultants’ figure of 16.8%. The main
cause of this underperformance seems to be the lower gross profit margin of 25%.
However, one can also conclude that Progress Ltd. Is deliberately charging a lower mark
up in order to increase sales by under cutting the market. This would explain the higher
inventory turnover at 4.5 times which is 50% better than the consultants’ figure
presumably the industrial/sector average.

The lower gross profit margin has fed through to contribute to a lower operating profit
margin of 7.5% compared to 12%. However, it seems Progress ltd has controlled its
operating cost better since operating costs constitute 17.5% of its revenue (25 - 7½) when
the sector average is 23% (35% - 12%) of revenue.

The lower ROCE may be due to poor assets utilization. It appears the rate for Progress
Ltd may have been distorted partly by the revaluation of property and the capitalization
of the differed development expenditure which has been included in the net assets, as the
net revenues expected form the development have not come on stream.

Liquidity
The current ration of Progress Ltd of 1.6:1 which is below the norm 2:1 is better than the
sector average of 1.25:1. The norm 2:1 is generally applicable and appropriate to
manufacturing concerns where the operating cycle is long. In the case of retail firms,
operating with 1.6:1 current ratio is not much of a worry. Indeed it’s better than the
sector average.

With a higher and better current ratio, higher inventory turnover of 4.5 times against
sector average of 3.5 times and trade payable payment of 45 days instead of 64 days
indicate conclusively that Progress Ltd has no pressing liquidity issues.

Gearing
The debt to equity ratio of Progress Ltd of 30% is an improvement over the sector
average of 38%. However the loan note interest of 20% which is higher than the return
on capital employed of12.1% implies that shareholders might be losing and therefore it
would not be in their interest to go for more loans. The finance charges of GH¢2,400,000
suggest that the loan was taken on July 1, 2012. If full year’s interest of GH¢4,800,000
would have had a more telling effect on profitability.

Conclusion
Management is right to be concerned with the profitability of Progress Ltd on the
contrary, Progress Ltd is performing quite well in terms of liquidity and gearing.
QUESTION 5
ANKONAM
(A) STATEMENT OF PROFIT AND LOSS FOR THE YEAR ENDED
31ST MARCH, 2011

GH¢

Revenue (716,900 – 54,000) 662,900

Cost of Sales (W1) (417,100)

Gross Profit 245,800

Distribution Costs (57,400)

Administration Expenses (30,000)

Profit on disposal of land & building (190,000 – 160,000) 30,000

Loss on abandonment of research project (60,000)

Finance Cost (W3) (22,400)

Profit before tax 106,000

Tax Expenses (30,000 – 4,400) (25,600)

Profit for the year 80,400

B]
ANKONAM
STATEMENT OF FINANCIAL POSITION AS AT 31ST MARCH, 2011

GH¢ GH¢
Tangible Non-current Assets

Property [400,000 – 12,000 (W2)] 388,000

Plant and Equipment (W4) 320,000

708,000
Current Assets

Inventories (56,480 + 45,000) 101,480

Accounts receivables (110,000 – 54,000) 56,000

Cash 21,320 178,800

886,800
Equity and Liabilities

Stated Capital 300,000

Retained Earnings (W5) 259,600

559,600
Non-current Liabilities

Amount due under Finance Lease (W6) 94,400

8% Loan Notes 100,000

Current Liabilities

Trade and Other Accounts Payable (W7) 102,800

Income Tax Payable 30,000

Total Equity and Liabilities 886,800

C] The directors’ proposed treatment of the deferred development expenditure is incorrect.

It needs to be written off because its value has become impaired due to adverse
legislation, not a change of accounting policy. It now has not effect value.

There has therefore not been a change of accounting policy, so it cannot be treated as a
period adjustment. It must be written off to the statement of profit or loss.

ANKONAM
WORKINGS GH¢

(W1 Cost of Sales

Per TB 370,100
Less Sales/Return (54,000 x 100) (45,000)
120
Add Depreciation (W2) 92,000
417,100
(W2) Depreciation
Building (200,000 + 50) 4,000
Healing System (40,000 + 10) 4,000
Lift (60,000 + 15) 4,000
Leased plant (160,000 x 20%) 32,000
Owned Plant (309,600 – 69,600) x 20% 48,000
92,000
(W3) Finance Cost
Loan Note Interest (100,000 x 8%) 8,000
Finance Lease (160,000 – 40,000) x 12% 14,400
22,400
(W4) Plant and Equipment
Cost: Owned Plant 309,600
Leased Plant 160,000
Depreciation: Owned plat (69,600 + 48,000) (117,600)
Leased Plant (160,000 x 20%) (32,000)
320,000
(W5) Retained Earnings GH¢

Balance b/f 143,200

Profit for the year 80,400

Revaluation Surplus Transfer (160 – 100) 60,000

Dividends Paid (24,000)

259,600

(W6) Lease Table

Yr Bal. b/f Rental Bal. Outstanding Int. at 12% Bal. c/f

2010 160,000 (40,000) 120,000 14,400 134,400

2011 134,400 (40,000) 94,400 11,328 105,728

(W7) Trade and Other Payables

Trial Balance 58,800

Amounts due under Finance Lease (120,000 – 94,400) 25,600

Accrued Interest (120,000 x 12%) 14,400

Accrued Loan note interest (100,000 x 8% - 4,000) 4,000

102,800
 THE INSTITUTE OF CHARTERED ACCOUNTANTS [GHANA]

PUBLIC SECTOR ACCOUNTING

NOVEMBER 2013 SOLUTIONS

QUESTION 1

A]
STATEMENT OF RECEIPTS AND PAYMENT OF THE CONSOLIDATED
FUND FOR THE YEAR ENDED 31ST DECEMBER 2012

RECEIPTS GH¢

Direct Tax 1, 044,460

Indirect Tax 939,556
Grants 28,110
Other Revenue 50,928
National Health Insurance Levy (NHIL) 79,368
Levies 27,184
Loans Received 4,245,150
Loans Recoveries 1,166
Total Receipts 6,415,922

PAYMENTS

Compensation of Employees 808,672

Goods and Services 404,336
Non-Financial Assets 134,779
Interest 398,138
Social Benefits 238,882
Other Expenses 159,255
Loan Repayments 3,056,000
Other Payments 68,428
Total Payments 5,268,490

Excess of Receipts over Payments 1,147,432

B]
STATEMENT OF CASH AND BANK BALANCES
FOR THE YEAR ENDED 31ST DECEMBER 2012

GH¢

Cash and Bank balances as at 1/1/2012 813,462

Excess of Receipts over Payment
during the year 1,147,432

Cash and Bank balances as at 31/12/2012 1,960,894

C]

The Financial Statement of the Consolidated Fund comprise:

(1) Statement of Financial Position or Balance Sheet

(2) A Statement of Revenue and Expenditure
(3) A statement of Receipts and Payments
(4) A Cash flow Statement
(5) Notes to the Accounts

QUESTION 2

A]
The required source documents include:

(a) Ministry of Finance release letter and warrant

(b) Controller & accountant General’s Department warrant
(c) Payment certificate
(d) Invoice and Vat Invoice
(e) Contract Agreement
(f) Award letter
(g) Evaluation Report
(h) Public Procurement Agency approval if restricted tendering method was used in procuring
the contract
(i) Evidence of advertisement in the dailies if competitive tendering method was used
(j) Purchase Orders (PO) and Store Received Advice (SRA)

B]
(1) OPERATION AND MAINTENANCE
In this model, the public authority contracts with a Private Partner to operate and
maintain a publicly owned facility or infrastructure.

(2) BUILD-OPERATE-TRANSFER (BOT)

In this model of PPP the private party is responsible for the Building and Operation of the
Infrastructure, which is used by the Public Sector. The ownership of the assets has to be
transferred to the Public Sector at the end of the contract.

(3) BUILD-TRANSFER-OPERATE (BTO)

This form of PPP is close to BOT, but in this form the Public Sector becomes the owner
of the infrastructure from the very beginning of the contract.

(4) BUILD-OWN-OPERATE (BOO)

Under this form, the Private Party provides for the construction, financing and operation
of the asset or infrastructure. The Private Sector will fully own the asset under financing.

(5) CONCESSION
In this form of PPP, “the Public authority entrusts to a third party, the total or partial
management of services for which that authority would normally be responsible and for
which the third party assumes the risk.”

The ownership of assets remains usually within the Public Sector, while the Private Party
is entitled to cover its expenditure through imposition of user fees.

C]
BENEFITS OF DUE PROCESS IN PROCUREMENT

1. To safeguard public funds and assets

2. To improve fiscal management through more efficient and effective expenditure
3. To enhance transparency and accountability in Governance
4. To rebuild public confidence in Government financial activities
5. To ascertain that Government receives value for money expended
6. To improve the system of planning and diligent project analysis leading to the accuracy of
costing and prioritization of investment.
QUESTION 3

A] - BUDGETARY POLICY OBJECTIVES OF GOVERNMENT

(1) ESTIMATE OF REVENUE AND EXPENDITURE

Through the annual estimate government is able to know the project revenue and
expenditure of the country for the budgeted year.

(2) ALLOCATION OF NATIONAL RESOURCES

Government through the annual estimate is able to know the allocation of funds for
various programmes including capital and recurrent expenditure.

(3) SECTORAL DISTRIBUTION

Through the estimates government is able to know the allocation of funds by sectors,
regions and districts.

(4) PUBLIC DEBTS AND INVESTMENTS

Government through the annual estimate is able to know whether it will have a surplus or
deficit on its current accounts and plan whether to borrow to meet the deficit or invest
surplus funds. It is also able to decide on the appropriate level and structure of public
debt required to meet a deficit.

(5) FISCAL AND MONETARY POLICIES

It is through the annual estimate that government is able to plan its fiscal policy (policy
on taxation) or monetary policy (policies on incomes, price stability and inflation).

B] ROLES OF INSTITUTIONS
(1) CABINET

Decision on government policies are taken by the executive arm of government as

represented by the office of the President and Cabinet. Government policies and
decisions invariably involve financial outlays, therefore the office of the President and
Cabinet have to exercise careful control on the government budget by making decisions,
choices and policies which do not overburden the Ghanaian tax payer.
(2) PUBLIC ACCOUNTS COMMITTEE

This Committee of Parliament examines the audited accounts of government in detail,

probing into instances of apparent waste, extravagance, fragrant disregard to regulations
etc. and summons Heads of Departments on whose accounts the Auditor –General
adversely report on to appear before it.

(3) HEADS OF MMDAS

These are responsible for the management, administration and implementation of the
objectives of government. Their financial management functions are:

- To regulate the financial management of the public sector

- Prescribe the responsibilities of persons entrusted with financial management in

MAAs and MMDAs and

- To ensure the effective and efficient management of state revenue, expenditure

control, assets, liabilities and resources of government.

C] The roles and responsibilities of Audit Report Implementation Committee [ARIC]

include:

1. Ensure the implementation of the recommendations in all audit reports of energy MDA or
MMDA.

2. Follow-up Auditor-General and Public Accounts Committee’s recommendations as well

as recommendations in Internal Audit Report.

3. Provide advice to management on:

- Risk management
- Internal Controls
- Compliance with laws, regulations ethical standards

4. Annually prepare a statement showing the status of implementation of recommendations

made in all Audit Reports.

D] FACTORS TO CONSIDER BEFORE INVESTING IN A PROJECT

1. Objectives are to be defined in relation to the long-term fundamental aims of the public
sector organization concerned.
2. There is the need for a technical feasibility which should identify whether there are legal
or political constraints. Proposed investment projects may have an impact on other
projects or may be dependent on the acceptance of other projects and the relationship of
projects will have to be taken into consideration.

3. It is important to assess the magnitude of the costs and benefits or cost effectiveness of
the project and also the expected timeframe they will occur.

4. It is important to realize that a sewage project may give the best value for money but
political factors and the need to respond to changes in governmental and societal
pressures may often make the implementation of the project difficult.

5. Environmental Considerations

6. Availability of funds or financing consideration

QUESTION 4

A] PROCEDURES FOR THE DISPOSAL OF ASSETS

1. POLICY IMPLICATIONS

The budget is a financial and quantitative statement that represents a number of intents
and policies. Although it identifies and quantifies targets and provides a framework for
management and control, the budget is essentially a forecast. As such budgets require
constant reviews to meet the objectives of the state.

2. PLANNING

Budget planning process requires detailed information of past performance,

determination of the present position and forecasting of the future. The planning process
must provide information about the structure and behaviour of expenditure, sources and
trends in revenue and demands of various government activities and functions. There is
therefore the need for constant monitoring of activities and programmes to ensure that
actual performance conforms with plans and corrective actions are taken on deviations
from plans.

3. DECISION MAKING

Budgetary review aids and stimulates decision making, choices, priorities, timing,
resource volume and expenditure. It assists the government to obtain detailed and better
understanding of how to formulate plans and achieve its objectives.

4. BUDGET IMPLEMENTATION
Actual performance of government compared with the budget may provide variances,
which should indicate the appropriate governmental action to be taken to steer its
operations in order to achieve its objectives. Budgetary review is an essential tool to
ensure that the implementation process stay on course.
B] FACTORS TO CONSIDER BEFORE BORROWING
1. COST OF BORROWING

The government wants to be sure that the cost of borrowing is as low as possible and that
it will not make unnecessary commitments, repayments and so on.

2. TERM OF LOAN

The government ensures that the most appropriate type of loan is obtained with regard to
its term. For example, if funds are required to cover expenditure (debt) payments at the
beginning of a month that will be covered by tax receipts two weeks later then only short-
term debt should be incurred. This will then be redeemed using the receipts.
3. CASH FORECAST

The government ensures that it has information to properly plan cash requirements. The
government needs to know when receipts are expected and payments must be made. It
can then make an informed decision on the amount and timing of the debt to be incurred.
4. TYPE OF LOAN
The type of debt to be incurred by government ought to be decided and negotiations
entered into to achieve the best terms possible. Early repayments, which reduce interest
charges, may also be planned if it is apparent that there will be surplus revenue.

5. INFRASTRUCTUAL NEEDS
6. REVENUE GENERATION
7. POLITICAL EXPEDIENCY

C] FINANCIAL INFORMATION TO BE EXPRESSED IN AUDITOR GENERAL’S

REPORT
(a) The profitability, liquidity, stability and solvency of the corporation, and also the
performance of the shares of the corporation on the capital markets where relevant.

(b) Whether there was delay in the payment of the government portion of any declared
dividend, if any, into the consolidated fund.
(c) Any significant cases of fraud or losses and the underlying causes
(d) The internal control weakness noted, and
(e) The general corporate performance indicating:
- Achievement against set targets and objectives and
- Whether the finances of the body have been conducted with due regard to economy,
efficiency and effectiveness having regard to the resources utilized.

D] CASH CONTROL MEASURES

1. Regular balancing of cash books

2. Establishment of cash limits
3. Daily banking of all takings
4. Periodic cash counts
5. Preparation of cash reconciliation statements
6. Provision of a fire proof safe
7. Investment of idle funds
QUESTION 5

A]
CONSOLIDATED FUND
STATEMENT OF CASHFLOW FOR THE
YEAR ENDED 31ST DECEMBER. 2012

OPERATING ACTIVITES GH¢

Other Payments (14,200)

Goods and services costs (202,168)
Compensation of employees (381,420)
Social Benefits (79,628)
Interest paid (318,511)
Taxes 976,778
Grants 14,056
Other Revenues Received 25,464
Other Receipts 53,277

INVESTING ACTIVITIES
Fixed Assets (20,000)
Inventory (25,008)
Work-in-Progress (12,120)
Sale of Fixed Assets 15,230
Shares and other equity purchased (28,130)
Advances Recovered 14,008
Advances Paid (583)
Securities other than shares (62,175)

FINANCING ACTIVITIES

Domestic Loans acquired 2,122,575

External Debts Paid (8,245)
Domestic Loans Paid (1,579,756)
B]
GROSS DEBT

It describes the total debt a government owes to outsiders. Gross debt represents only a part of a
government’s total liabilities. It is just one item reported on the statement of financial position.

TOTAL LIABILITIES

It represents all of the amounts the government owes to external parties, including, government
employees. They include accounts payable, issued debts, employee pension and other obligations
as well as other amounts owing to individuals and organization outside of the government.

NET DEBT
It describes one indicator of government financial position. This indicator takes into account the
value of many items reported in the statement of financial position. It is calculated as the
difference between the sum of all of a government’s financial assets and the sum of all its
liabilities.

C]
REASONS FOR REPORTING THE COST OF SERVICES

1. Provides accountability for the total costs of services for each major government
function.

2. Allows readers to compare costs with those incurred in the prior year and with those of
the budget.

3. Allows financial statements users to compare the costs of each government functions to
its total costs and thus obtain information about the government priorities for example the
percentage of the services to the total government revenue.
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

QUESTION 1

(a) Currency management has become an increasingly important issue for many
organizations as they become more dependent on purchasing goods and services on a
global basis.

Required:

(i) Assess four (4) main reasons for the volatility of exchange rates (6 marks)

(ii) Compare the use of spot and forward exchange rates in the management of currencies
by organizations in a supply chain (6 marks)

(b) (i) Briefly discuss different forms of business acquisition (4 marks)

(ii) Briefly discuss four (4) takeover defences (4 marks)

(Total: 20 marks)

Page 1 of 6
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

QUESTION 2

(a) Profin Financial Services granted a loan of GH₵22,000 to its client at 12% compound
annual interest to be repaid over the next six (6) years. As financial adviser to the client
you are required to

(i) Compute the size of the yearly payments (2 marks)

(ii) Construct an amortization schedule. (4 marks)

(b) When the market return is 12%, company A’s shares give a return of 16%. When the
market return rises to 14%, company A’s shares give a return of 19%. The risk-free rate
of return does not change.

You are required to calculate:

(i) What is company A’s beta value?

(ii) What is the risk-free return?
(6 marks)

(c) Carsley Ltd and Powell Ltd are planning to merge to form Stimac Ltd. It has been agreed
that Powell’s shareholders will accept three shares in Carsley for each share they hold.
Other details are as follows:

Carsley Ltd Powell Ltd

Number of shares 40m 10m
Annual earnings GH₵10m GH₵5.8m
P/E ratio 8 10

Post-merger annual earnings of the enlarged company are expected to be eight percent (8%)
higher than the sum of the earnings of each of the companies before the merger, due to
economies of scale and other benefits. The market is expected to apply to P/E ratio of 9 to
Stimac Ltd.
Required:
Determine the extent to which the shareholders of Powell will benefit from the proposed merger.

(8 marks)

Page 2 of 6
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

(Total: 20 marks)

QUESTION 3

Adepa Ltd has just acquired a large account. As a result it needs an additional GH₵75,000 in
working capital immediately. It has been determined that there are three feasible sources of
funds:

(a) Trade Credit: the company buys about GH₵50,000 of materials per month on terms of
2/30, net 90. Discounts are taken.

(b) Bank Loan: the firm’s bank will loan GH₵100,000 at 9%. A 20% compensating balance
will be required.

(c) A factor will buy the company’s receivables (GH₵100,000 per month), which have a
collection period of 60 days. The factor will advance up to 75% of the face value of the
receivables for an annual charge of 8%. The factor will also charge a 2% fee on all
receivables purchased. It has been estimated that the factor’s services will save the
company a credit department expense and debts expense of GH₵1,500 per month.

You are required to determine which alternative should be selected.

(15 marks)

(b) The shares of ALOP Enterprise has a beta of 1.5 and that of Zebra Enterprise has a beta
of 0.7. The risk free rate is 7% and the difference between the expected return on the
market and the risk free rate is 8.5%

Required:

Calculate the expected return on the two (2) securities. (5 marks)

(Total: 20 marks)
Page 3 of 6
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

QUESTION 4

(a) The chemical division of a company has a capital budget for 2014 of GH₵1,000,000.

The following capital investment proposals are submitted to the capital budgeting committee:

Project Profitability Index Outlay (Gh₵)

1 1.20 200,000

2 1.18 200,000

3 1.17 100,000

4 1.10 300,00

5 1.15 200,000

6 1.13 200,000

7 1.19 400,000

8 1.21 100,000

9 1.22 100,000

10 1.16 100,000

The company’s cost of capital is 15% per annum.

Project 2 and 8 are mutually exclusive; project 1 and 5 are mutually dependent.

Required:
Decide which projects should the capital budgeting committee choose?

(15 marks)

Page 4 of 6
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

(b) What are the major considerations that the predator company has to take into account
when deciding on how to finance a proposed take-over?
(5 marks)

(Total: 20 marks)

QUESTION 5

Adomako plans to invest in ordinary shares for a period of fifteen years, after which he will sell
out, buy a lifetime room-and-board membership in a retirement home and retire. He feels that
Smirsh Ltd is currently, but temporarily, undervalued by the market. Adomako expects Smirsh’s
current earnings and dividend to double in the next fifteen years. Smirsh’s last dividend per share
was GH₵3, and its share currently sells for GH₵35 a share.

(a) If Adomako requires a 12% return on his investment, will Smirsh be a good buy for him?

(6 marks)

(b) What is the maximum that Adomako could pay for Smirsh and still earn his required
12%?

(4 marks)

(c) What might be the cause of such a market undervaluation? (6 marks)

(d) Given Adomako’s assumptions, what market capitalization rate for Smirsh does the
current price imply?

(4 marks)

(Total: 20 marks)
Page 5 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)
FINANCIAL MANAGEMENT QUESTION PAPER
NOVEMBER 2014

Page 6 of 6
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

SOLUTION 1

(a) The reasons for the volatility in exchange rates are:

(i) Supply and demand: like any commodity, the value of a currency rises and falls in
response to the forces of supply and demand. Businesses and consumers need to
spend and consumer spending directly affects the money supply and so exchange
rates are primarily driven by the supply and demand in foreign exchange markets.

(ii) The level of interest rates: central banks and governments influence interest rates
that regulate borrowing in an economy. Interest rates set the base rates for banks and
other financial institutions to charge customers to borrow money. For instance, if the
economy is under-performing, central banks may lower interest rates to make it
cheaper to borrow; this often boosts consumer spending, which may help expand the
economy.

(iii) Employment outlook: employment levels can usually have an immediate impact on
economic growth. As unemployment increases, consumer spending falls because
jobless workers have less money to spend on non-essentials. Those still employed
tend to reduce their spending and save more of their income. An increase in
unemployment signals a slowdown in the economy and a possible devaluation of a
country’s currency because of declining confidence and lower demand.

(iv) Economic growth expectations: to meet the needs of a growing population, an

economy must expand. An expanding economy will generally lead to a strengthening
of their currency. However, if growth occurs too rapidly, the higher growth creates
higher inflation, and this trend can weaken the country’s exchange rate. Deflation is
the opposite of inflation; it occurs during times of recession and is a sign of economic
stagnation and this can lead to a fall in the value of currency against stronger
countries.

(v) The balance of trade: a country’s balance of trade is measured by the total value of
its exports, minus the total value of its imports. If this number is positive, the country
is said to have a favourable balance of trade. If the difference is negative, the country
has a trade gap, or trade deficit. The trade balance then impacts on supply and
demand for a currency.
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 1 of 12
(vi) Central government intervention: with interest rates in several major economies
already very low (and set to stay that way for the time being), central bank and
government officials are now resorting to other, less commonly used measures to
directly intervene in the market and influence economic growth. For example,
quantitative easing is being used to increase the money supply within an economy. It
involves the purchase of government bonds and other assets from financial
institutions to provide the banking system with additional liquidity.

(vii) Economic factors: these include government and central bank policies such as,
government budget surplus or deficits, inflation level, economic growth, balance of
payments, regulations on transfer of funds and interest rates levels.

(viii) Political factors: political factors impact on foreign currency trading or exchange
rate by affecting the supply and demand for such currencies. Some of the indicators
of political factors are stability of the political system, type of governance –
democracy or military rule and peace or stability in the sub region.

(ix) Market psychology: the traders’ perception and the way the market view a particular
currency influence the exchange rate. When there is an event where traders think
they may make a loss in a particular currency, they will move their funds to a more
stable fund. This is referred to as flights to quality. There are instances when the
market may act based on rumour but the actual development may be the same the
rumour or be different. This is referred to as buying the rumour and selling the
fact. Economic indicators including profit released by firms, inflation, 91 day
Treasury bill interest rate and economic growth impact on market view of a particular
currency.

(x) Technical trading: some market watchers study movements in exchange rate over
time and use this information to buy and sell a particular currency.

(i) A spot rate is the exchange that is being offered at the current time for an
immediate transaction. The spot foreign exchange (forex) rate differs from
the forward rate in that it prices the value of currencies compared to foreign
currencies today, rather than at sometime in the future. The spot rate in forex
currency trading is the rate that most traders use when trading with an online
retail foreign exchange broker.
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 2 of 12
(ii) A currency futures or forward contract is a legally binding contract that
obligates the two parties involved to trade a particular amount of a currency
pair at a predetermined price (the stated exchange rate) at some point in the
future. Assuming that the seller does not prematurely close out the position,
they can either choose to own the currency at the time the future is written, or
may speculate that the currency will be cheaper in the spot market sometime
before the settlement date. Higher grades will be awarded to candidates that
offer a clear explanation of the use of currency options. These allow the right
to buy or sell a specific exchange rate at a future date. A future option allows

The option holder the right to either buy or sell a currency in the future
depending on the movement of exchange rates.

(b) (i) The main different forms of business acquisition are as follows:

(a) Horizontal merger: it is a merger between business competitors who are manufactures
or distributors of the same type of products or who render similar or same type of
services for profit. It involves joining together of two or more companies which are
producing essentially the same products or rendering same or similar services or their
products and services directly compete in the market with each other. It is a combination
of two or more firms in similar type of production/distribution line of business.
Horizontal mergers result in a reduction in the number of competing companies in an
industry; increase the scope for economies of scale and elimination of duplication
facilities. However, their main drawback is that they promote monopolistic trend in the
industrial sector as the number of firms in an industry is decreased and this may make it
easier for the industry members to collude for monopoly profits.

(b) Vertical merger: vertical mergers occur between firms in different stages of production
operation. In a vertical merger two or more companies which are complementary to each
other for example one of companies is engaged in the manufacture of a particular product
and the other an expert in the marketing of that product or is engaged in production of
raw material or ancillary items used by the other company in manufacturing or
assembling the final and finished product join together. In this merger the two companies
merge and control the production and marketing of the same product. Vertical merger
may take the form of forward or backward merger. When a company combines with the
supplier of material, it is called a backward merger and where it combines with the
customer, it is known as forward merger. A vertical merger may result into a smooth and
efficient flow of production and distribution of a particular product and reduction in
handling and inventory costs. It may also pose a risk of monopolistic trend in the
industry.
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 3 of 12

(c) Conglomerate merger: this type of merger involves coming together of two or more
companies engaged in different industries and/or services. Their businesses or services
are neither horizontally nor vertically related to each other. They lack any commodity
either in their end product, or in the rendering of any specific type of service to the
society. The merging companies operate in unrelated markets having no functional
economic relationship.

(ii) Takeover defences can be either pre bid or post bid. These are provided below:

(a) Pre-bid defences – strategies to adopt to prevent a company bidding to acquire

your company: the simplest and most constructive form of pre-bid defence is to
make a company too expensive to take over in the first place. This form of defence is
consistent with the objective of shareholder wealth maximization and can be achieved
through the following means.

1. Improving operational efficiency: rationalizing production, cutting overheads

and improving labour productivity can raise a company’s EPS and share price,
making a potential takeover both more expensive and less likely.

2. Examining asset portfolios and making necessary divestments: managers can

sell of non-core, low-growth business and concentrate on the markets in which
they have relative strengths. Again, this should lead to higher profits and a higher
EPS and share price.

3. Ensuring good investor relations: maintaining good relations with both

investors and analysts can make a takeover both more difficult and more
expensive. Companies should keep investors well informed about company
strategy, policies and performance and also try to satisfy investors’ risk-return
preferences. Less desirables types of pre-bid defences are those put into place
with the sole purpose of making a company both difficult and expensive to take
over. These obstructive defences are often at odds with shareholder wealth
maximization and include the following techniques.

4. Restricting of equity: a number of tactics are available within this area. For
example, companies can repurchase their own shares to make it more difficult for
predators to build up a controlling position, or they can increase their gearing
level in order to make themselves less attractive to bidding companies. More
intriguingly, companies can plant poison pills within their capital structure, for
example options giving rights to shareholders to buy future loan stock or
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

preference shares. If a bidding company tries to take over the company before the
rights have to be exercised, it is obliged to buy up the securities, hence increasing
the cost of the acquisition.

Page 4 of 12

5. Management retrenchment devices: the best known of these are golden

parachutes, which give extremely generous termination packages to senior
managers and thereby increase the cost of the takeover as substantial amounts of
money are needed to remove incumbent managers. However, this form of
takeover defence is becoming increasingly unpopular with institutional investors.

6. Strategic defence via cross-holdings: this defence ensures that a significant

proportion of equity is in friendly hands through companies arranging to take a
mutual shareholding in each other in order to block potential takeover bids.

(b) Post-bid defences-Strategies to adopt to prevent acquisition after a bid is made:

post bid defences are used by target companies to repel a bid once one has been
made. Post-bid defences that are often used include the following:

1. Rejection of the initial offer: when a takeover bid is made, the bid is attacked to
signal to the predator that the target company will contest the takeover. In some
cases, this may be sufficient to scare the predator off.

2. A pre-emptive circulation to shareholders: target companies can appeal to their

own shareholders, explaining why the bid is not in their favour from both a logical
and price perspective.

3. Formulation of a defence documents: the board of the target company can prepare a
formal document for circulation among its own shareholders which praises the
company’s performance and criticizes the bidding company and its offer.

4. Profit announcements and forecasts: the defending company can produce a report
which indicates that its forecast profits for the future will be much better than those
expected by the market. If these revised forecasts are accepted by the market, this
acceptance will force up the market price and make the proposed takeover more
expensive. A major problem here is that, if the company does not meet these
increased forecasts, its share price is likely to fall, putting it at risk from another
takeover bid and making it less likely that such a defence will be successful when
used again.

5. Dividend increase announcements: a company can announce an increase in current

dividend and an intention to pay increased dividends in the future. This expected
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

increase in shareholder returns may dissuade them from selling their shares. Equally,
they may query why increased returns were not paid prior to the arrival of a takeover
bid.

Page 5 of 12

6. Revaluation of assets: before or after a bid is made a company can revalue certain
assets on its balance sheet, such as land and buildings, or capitalize intangible assets
in its balance sheet, such as brands and goodwill, in order to make the company look
stronger or more valuable. While this may lead to the predator having to make an
increased offer, it could be argued that, if capital markets are efficient, no new
information is being offered to the market and the existing share price is a fair one.

7. Searching for a white knight: the target company can seek a more suitable company
to take it over, although this tactic tends to be used only as a last resort. This tactic is
allowed but if the target company passes any information to the ‘white knight’ it must
also be passed to the initial predator. A variation of this technique is to issue new
shares to a ‘white knight’ in order to dilute the predator company’s holdings. The
defending company must get its shareholders’ approval before it defends the takeover
bid in this way, however.

8. Pac-man defence: this defence involves the target company making a counter-bid for
the shares of the predator. This option is difficult to organize and expensive to carry
out, but it has been used on some occasions.

9. Acquisitions and divestments: the target company can either buy new assets or
companies that are incompatible with its predator’s business or sell the ‘crown
jewels’ or assets that the predator company is particularly interested in.
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 6 of 12
SOLUTION 2
n
(a) 1- 1
1+K
A
(i) P= K = A 1 – (1 + K)-n
K

22,000 = A 1 – (1 + 0.12)-6
0.12 = A = 22,000 = 5,351.49
4.111

(ii) Amortization schedule

Year Beginning Interest Principal Total Closing

Balance Payment Balance
1 22,000.00 2,640.00 2,711.00 5,351.00 19,289.00
2 19,289.00 2,314.68 3,036.32 5,351.00 16,252.68
3 16,252.68 1,950.32 3,400.68 5,351.00 12,852.00
4 12,852.00 1,542.24 3,808.76 5,351.00 9,043.24
5 9,043.24 1,085.19 4,265.81 5,351.00 4,777.43
6 4,777.43 5,73.29 4,777.71 5,351.00 - 0.28

(b) (i) Since the risk-free rate does not change, the market excess return increases by the
same amount as the market return: 2 percent. Similarly, company A’s excess return
increases by 3 percent. So company A’s beta value is:

Company’s A beta value is = 19% - 16% = 3 = 1.5

14% - 12% 2

(ii) Company A’s excess return = 1.5 x market excess return

So before the change: 16% = r + 1.5 (12% - r)
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

16% = r + 18% - 1.5r

1.5r – r = 18% - 16%
2%
0.5r = 2% = r = 0.5 = 4%
r = 4%

Page 7 of 12
(c) Powell’s market value using its P/E and earnings is 5.8m x 10 = GH¢58m

The earnings of Carsley Ltd will be (GH¢10m + GH¢5.8m) x 1.08 = GH¢17.06m

Using the expected P/E ratio of 9, the value of Carsley is GH¢17.06m x 9 =
GH¢153.54m

The 10 million shares of Powell will be swapped for 30 million Carsley shares, making
70 million shares in the new company in total.

Therefore, the wealth of Powell’s shareholders will now be GH¢153.54m x (30m/70m) =

GH¢65.8m.

Powell’s shareholders are GH¢7.8m better off (78Gp per share).

SOLUTION 3

(a) Cost of trade credit

2% of 50,000 x 360
50,000 – (2% of 50,000) 90 – 30 = 12.24% or

2% of 50,000 x 365
50,000 – (2% of 50,000) 90 – 30 = 12.41% or

2 x 360
98 90 – 30 = 12.24% or

2 x 365
98 90-30 = 12.41%

(b) Cost of bank loan

 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

9% = 11.25%
80%

(c) Cost of factoring

Factor fee per year = 100,000 x 12 x 0.02 = 24,000
Credit department expense and debt expense savings = 1,500 x 12 = 18,000
Net factor cost = 24,000 – 18,000 =

Page 8 of 12
Current level of debtors = 60/365 x 1,200,000 = 197,260.27
75% of the advance = 197,260.27 x 0.75 = 147,945.21
Interest on the advance = 8/100 x 60/365 x 147,945.21 = 1,945.58
Advance to be paid = 147,945.21 – 1,945.58 = 145,999.63
Annual interest charge = 1,945.58 x 365/60 = 11,835.6
Total cost of factoring = 11,835.6 + 6,000 = 17,835.6
Effective cost of factoring = 17,835.6/145,999.63 * 100 = 12.22%

(d) The expected return of the two(2) securities are as follows:

ALOP = 7% + 1.5 x 8.5 = 19.75%

Zebra = 7% + 0.7 x 8.5 = 12.95%

 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 9 of 12
SOLUTION 4

Project Profitability Outlay PV NPV Ranking Ranking

Index per NPV per P1
1 1.20 200,000 240,000 40,000 2 3
2 1.18 200,000 236,000 36,000 3 5
3 1.17 100,000 117,000 17,000 8 6
4 1.10 300,000 330,000 30,000 4 10
5 1.15 200,000 230,000 30,000 4 8
6 1.13 200,000 226,000 26,000 5 9
7 1.19 400,000 476,000 76,000 1 4
8 1.21 100,000 121,000 21,000 7 2
9 1.22 100,000 122,000 22,000 6 1
10 1.16 100,000 116,000 16,000 9 7

(a) Ranking per NPV = Project 7, Project 1, Project 2 and Project 5

Ranking per P1 = Project 9, Project 8, Project 1, Project 7 and Project 2 (Project 3 and
Project 10 to replace Project 2)

Since project 2 and 8 are mutually exclusive but project 1 and 5 are mutually dependent
select project by P1 ranking as above

(b) There are a large number of factors that will influence a company on the way it decides to
structure its financing of a takeover bid, as follows:
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

 The tax position of the target company’s shareholders: if they are tax exempt, they
may prefer a cash offer as they will not incur capital gains tax. If they are liable
for capital gains then they may prefer a share-for-share offer. If there is a diverse
range of investors in different tax-paying positions then a mixed bid may be more
appropriate.

 The acquiring company’s level of liquidity and ability to borrow funds: this will
determine whether it will be able to find sufficient funds in order to make a cash
offer.

 The acquiring company’s share price: if its share price is high compared to the
victim company’s share price, the predator company will not have to issue too
many shares if it makes share-for-share offer, reducing any potential dilution of
EPS and control.

Page 10 of 12

 The attitudes and preferences of shareholders: the predator company’s

shareholders may not want it to borrow for a cash offer because this may increase
financial risk beyond what they are prepared to tolerate. A cash offer may be
unattractive to the victim company’s shareholders because they no longer have a
participating interest in the company that they originally bought shares in.

SOLUTION 5

(a) Present dividend = GH¢3

Expected to double in 15years time = GH¢6
Let us determine the growth in 15 years time.
3(1 + g) 15 = 6
(1 + g) 15 = 6/3
(1 + g) 15 = 2
(1 + g) 15 x 1/15 = 2 (1/15)
(1 + g) = 1.04729
g = 1 – 1.04729 = 4.73% or 5%

Using dividend growth model we can obtain price of the share

P = 3 (1 + 1.05)
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

0.12 – 0.05 = 45

Since the shares are selling for GH¢35and have a computed value of GH¢45, they are a
good buy for Adomako.

(b) The maximum that Adomako could pay for Smirsh and earn the required 12% is GH¢40
which gives a required return of 12.5% (45/40*1-1=12.5%)

(c) Cause of market undervaluation of stocks are as follows:

(i) Poor performance

(ii) Inability of investors to perceive the future growth of the company
(iii) Low marketability of shares
(iv) Irregular or fluctuating dividend payment
(v) Higher risks than expected future returns
(vi) General market recession
(vii) General instability in an economy

Page 11 of 12

(d) Implied market capitalization can be obtained using the dividend growth
model r = D1 + g
P

= 3 (1 +1.05) + 0.05
35
= 0.14 or 14%
 THE INSTITUTE OF CHARTERED ACCOUNTANTS (GHANA)

SOLUTION: FINANCIAL MANAGEMENT, NOVEMBER, 2014

Page 12 of 12
 THE INSTITUTE OF CHARTERED ACCOUNTANTS, GHANA
NOVEMBER 2015 PROFESSIONAL EXAMINATIONS
EXAMINERS GENERAL COMMENTS
FINANCIAL MANAGEMENT (2.4)

GENERAL COMMENTS

November 2015 examination is the second diet of the New Syllabus introduced by the Institute.
Five compulsory questions were set in the examination, each worth 20 marks. Almost all the
candidates attempted all the five questions and there was little evidence of time pressure. Many
candidates performed particularly well on questions 1a, 1c, 1d, 2a ,2c, 3a, 3b, 4a (ii) 5b,5(c) and
5d. These questions were all largely written in nature. The questions candidates found most
challenging were questions 1b, 2b, 3c, 4a (i), 4b, 4c and 5a. These questions were all largely
numerical in nature and were perhaps challenging because some candidates lacked
understanding of numerical part of the syllabus. Common issues relating to candidate’s answers
are highlighted as follows:
 Some candidates did not read the question requirement clearly and therefore gave
irrelevant answers which scored few (if any) marks;
 Poor time management between questions. For example, some candidates wrote too
much for the marks on offer;
 Illegible handwriting and poor formatting of answers.

QUESTION ONE

a. One of the key expectations of the Finance Manager is to ensure the success of the
organisation. Describe FOUR (4) key factors that are indicative of a successful
organisation. (4 marks)

b. The Board of Directors of Suncity Limited are reviewing the performance of their
business for the year 2014 and are considering using ratio analysis for this purpose. You
have been presented with the following statement of comprehensive income for the
years 2013 and 2014

Page 1 of 19
 2014 2013
(GH₵’000) (GH₵’000)
Sales 42,000 30,000
Less cost of sales 33,200 21,500
Gross profit 8,800 8,500
Operating expenses 2750 2120
Profit before finance charges 6,050 6,380
Finance charges 500 700
Profit before tax 5,550 5,680
Taxation 1110 1136
Profit after tax transferred to income surplus 4,440 4,544

Required:

i. Compute common size ratios for Suncity Limited for 2013 and 2014 (4 marks)
ii. Comment on any four of the ratios computed (2 marks)

c. The quarterly report of the treasury unit of Buruwa Limited contains a paragraph on
government policy targets and progress towards achievement of the targets. The
Technical Director has express disagreement about the time spent in discussing these
policies as wasteful because the policies have no relevance to the business activities of
the confectionery company.

Required:
As Head of Finance, you have been tasked to discuss SIX (6) points on government
revenue mobilisation policies to agree or disagree with the Technical Director’s
position

(6 marks)

d. Explain the following terms

i. Financial intermediation (2 marks)
ii. Financial disintermediation (2 marks)
(Total: 20 marks)

Page 2 of 19
QUESTION TWO

a. A good working capital policy should facilitate successful achievement of the key short
term financing objectives of an organisation.
Required
Identify the three types of working capital policies of an organisation (5 marks)

b. This Way Ltd is preparing a business plan to apply for a grant from EDAIF for an
expansion of its rice production. Current production is 20,000 bags at a variable cost per
bag of GHS12.00 and contribution sales ratio is 25%. Variable cost is for purchases.
Current receivable days is 30 days and inventory turnover is 12 times. Suppliers allow
15 days credit and the company maintains absolute cash ratio of 1:1.

The funding support from EDAIF is expected to double the production capacity of the
company. Inventory and absolute cash ratios would be maintained but receivables and
payables days will increase to 45 days and 30 days respectively. EDAIF policy is to
support only the extra working capital needs of applicants.

Required:

Determine the amount that should be applied from EADIF (10 marks)

c. Sankofa Ltd has a dividend cover of 4 times and recorded the following earnings after
tax.
Year Earnings(GH₵)
2010 100,000
2011 120,000
2012 180,000
2013 220,000
2014 300,000

Required:

Calculate the average dividend growth rate for Sankofa Ltd (5 marks
(Total: 20 marks)
Page 3 of 19
QUESTION THREE

a. Describe FOUR (4) ways in which the investment appraisal approach of a Municipal
Assembly will differ from a mining company (4 marks)

b. God is King Ltd has been printing all its magazines from Dubai due to the comparative
cost advantage. The company is considering establishing its own printing department,
and the R&D team have identified a printing machine which will meet the quality and
cost specifications of God is King Ltd. The machine also has the capacity to print to
meet the market needs of the company. The machine, which has a useful life of 5 years,
will cost GHS800,000 and immediate installation cost will be GHS50,000. Fixed cost
for maintaining the machine will be 170,000 per annum over the machines useful life
and additional working capital of 30,000 will be introduced in year 2. The use of this
machine will generate a contribution of GHS 500,000 per annum for five (5) years.
Corporate income tax rate, payable in areas, is 25% and the companies after tax cost of
capital is 20%. No capital allowance is permitted.
Required:
Calculate the NPV for the project and advise management on whether to accept or
reject the project. (10 marks)

c. Explain the following types of contracts

i. Mudaraba contract (2 marks)
ii. Musharaka contract (2 marks)
iii. Murabaha contract (2 marks)

(Total: 20 marks)

Page 4 of 19
QUESTION FOUR

a. Dinpa Supermarket is considering acquiring a loan of GH₵300,000 from Abrempong

Bank Ltd. The loan is payable in five equal annual instalments at an interest rate of 25%.
Dinpa Ltd has consulted you to determine their annual repayment amount and the
interest thereon.

Required:

i. Prepare a repayment schedule for Dinpa indicating clearly the interest payment and
the principal repayment (8 marks)

ii. State THREE (3) advantages of a term loan over an overdraft facility (3 marks)

b. On 1st January 2010, Exchequers Insurance issued a 15% convertible bond quoted at
GH₵123. The nominal value for each bond is GH₵100 and the conversion date for the
bond is 31st December 2015 after interest have been paid. The bond is convertible at 20
ordinary shares per GH₵100 bond. The current price per share is GH₵6.

Required:

i. Determine the conversion rate. (2 marks)

ii. Determine the conversion premium. (2 marks)
iii. Comment on the possibility of bond holders converting for shares. (2 marks)

c. State TWO (2) key assumptions of the random walk theory. (3 marks)
(Total: 20 marks)

QUESTION FIVE

a. Explain the following terms

i. Interest rate parity (2 marks)
ii. Purchasing power parity (2 marks)

b. Skytrain, a music production company imported musical instruments from Sweden for
Krona 2,100,000 at a rate of Krona 7.00 to GH₵1.00. Skytrian sold the goods for

Page 5 of 19
 GH₵600,000 after paying shipping cost of GH₵50,000 and bank transfer charges of
GH₵5,000 and Krona 10,000. At the time of paying the bank charges, the Krona was
traded at 5 to GH₵1.00.
Required
Calculate the profit or loss on this transaction (5 marks)

c. Identify five (5) distinguishing features of currency futures contract and a forward
contract. (5 marks)

d. I, me, and myself have shares in a company which paid dividend of GH₵10 to its
shareholders. The shares has a beta factor of 1.2. The risk free rate of return and the
market return are 15% and 20% respectively.

Required:

i. Calculate the return on the shares (4 marks)

ii. Calculate the value of the shares (2 marks)
(Total: 20 marks)

Page 6 of 19
 SUGGESTED SOLUTIONS

QUESTION ONE

Four (4) key factors that are indicative of a successful company:

 Profitability – the operations of the company should be profitable to enable it pay

adequate returns to its investors and retain some for reinvestment;
 Market share – the company should grow and maintain its market share to enable it
continue to have demand for its products and thereby generate adequate revenue from
its sales;
 Growth – growth is one of the key expectations of every organisation, expanding in its
operations scope of coverage and investment size;
 Cash flow – have adequate cash flow to meet its operational cost, service loans and
other debts as and when they fall due;
 Customer satisfaction – have to be competitive by meeting the expectations of
customers, their changing needs and preferences. This also enhances the company’s
competitive advantage;
 Quality of products – the quality of products at the most competitive price also enables
the company to attract and retain customers to enable it expand its customer base, grow
to enjoy economies of scale which will lead to lower cost and increased profit;
 Industrial relations – industrial relationship is key to enhancing the organisations
bargaining power, and obtain information about developments in the industry to enable
it respond appropriately;
 Added value – this enable the company to position itself in society as a good cooperate
citizen, providing services to society to enhance its public image;
 Highly skilled personnel – highly skilled improve efficiency, quality and creativity to
pursue to mission of the organisation in the most cost effective manner.
(1 mark for each point up to a maximum of four (4) marks)

Page 7 of 19
b. (i) Suncity Limited common size ratio for the 2014 income statement –

Income statement Common size ratios

2014 (₵’000) 2013 (₵’000) 2014% 2013%

Sales 42,000.00 30,000.00 100 100

Less cost of sales 33,200.00 21,500.00 79 72

Gross profit 8,800.00 8,500.00 21 28

Operating expenses 2,750.00 2,120.00 7 7

Profit before finance charges 6,050.00 6,380.00 14 21

Finance charges 500.00 700.00 1 2

Profit before tax 5,550.00 5,680.00 13 19

Taxation 1,110.00 1,136.00 3 4

Profit after tax transferred to income surplus 4,440.00 4,544.00 11 15

¼ marks for each ratio up to 16 ratios computed correctly.

b. (ii) comments on the ratios. Any four (4) correct commentary – Horizontal analysis –
changes between 2013 and 2014, or vertical analysis for 2marks

c. Monetary policy and its effect on business

Government aims at controlling the amount of money in circulation. Government policies to
reduce money in circulation can affect business activities in several was as follows.

 Affect borrowing cost as government may increase its borrowing rates to attract
patronage of government bills and bonds with the view to mopping up excess liquidity
 Policies may divert investment from the private sector as strict credit controls will
limit amount available for credit
 There could be difficulties in securing funds for expansion and long term projects
 Increased borrowing cost will put pressure on share prices thereby making it difficult
to raise funds from shares
 There would be decrease in consumer demand as a result of increased prices from the
high interest
 Decrease in disposable income due to increase in loan and mortgage repayments
 High interest rate may increase the cost of local produce and thereby encourage
consumption of imports

Page 8 of 19
  The increase in consumption of imports can result in balance of payment difficulties if
exports fall as a result of increase in the prices of exports. Increased imports will result
in increased demand for foreign currency leading to depreciation of the local currency

(1 mark for each correct point up to a maximum of 6 marks)

d. (i) Financial intermediaries

Financial intermediaries are financial institutions established to mobilise funds from lenders
and channel them to borrowers
(ii) Financial disintermediation

Disintermediation is the use of financial market for lenders and borrowers to directly transact
thereby eliminating the functions of intermediaries.

EXAMINER’S COMMENT

Question One (a)

This question required candidates to describe four (4) key factors that are indicative of a
successful organization. Most candidates did well on this part of question 1. Most candidates
identified indicative factors of a successful organization though few of them thought the
question asked for the role of the finance manager.

Question One (b)

Candidates were asked here to compute common size ratios though the topic is no more under
the new syllabus. Most candidates performed poorly in answering this question.

Question One (c)

This part of question 1 required candidates to identify the importance of discussion on
government policy targets and progress towards achievement of these targets. This question
seemed familiar with students and answers provided by candidates generally addressed the
requirement of the question.

Question One (d)

Candidates were asked to explain the terms financial intermediation and financial
disintermediation. Answers to this question were generally good.

Page 9 of 19
QUESTION TWO
a. Forms of working capital policy
Restrictive or aggressive approach
With a restrictive policy, current assets are financed through short term funds. Firms with
restrictive working capital policies demonstrate the following:
 Keeping low cash balances and making little investment in marketable securities;
 Making small investments in inventory;
 Allowing few or no credit sales, thereby minimizing accounts receivable. 2 marks
Flexible or conservative approach
Firms that adopt a flexible or conservative approach to the management of working capital to
have a higher investment in current assets. The objective is to reduce the risk of stock out and
to maintain high liquidity. Flexible or conservative approach to working capital management
results in the following:
 Keeping large balances of cash and marketable securities;
 Granting liberal credit terms, which results in a high level of accounts receivable;
 Making large investments in inventory. 2 marks
Moderate approach
This is the middle ground between the conservative and the aggressive approach 1 mark
b. Working capital needs

Current Future
Production 20,000.00 40,000.00

Selling Price GHS (12/(1 - 0.25) 16 16 1 mark

Sales (GHS) 320,000.00 640,000.00 1 mark

Purchases GHS (12) 240,000.00 480,000.00 1 mark

Working capital needs

Inventory 20,000.00 40,000.00 1 mark

Receivables 26,301.37 78,904.11 1 mark

Cash 9,863.01 39,452.05 1 mark

Current Assets 56,164.38 158,356.16 1 mark

Payables (9,863.01) (39,452.05) 1 mark

Working capital 46,301.37 118,904.11 1 mark

Page 10 of 19
Amount required from EDAIF = 118,904.11 – 46,301.37 = 72,602.74 1 mark
c. Sankofa dividend growth rate
1
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑥 4

Year Earnings(₵) Dividend

0.5 marks
2010 100,000.00 25,000.00
0.5 marks
2011 120,000.00 30,000.00
0.5 marks
2012 180,000.00 45,000.00
0.5 marks
2013 220,000.00 55,000.00
0.5 marks
2014 300,000.00 75,000.00

Total for the table is 2.5 marks

𝑑𝑛 1/𝑝
Dividend growth rate = [( ) ]− 1
𝑑0

Where
𝑑𝑛 = 75,000
𝑑0 = 25,000
𝑝=4
1
75,000 4
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 = [(25,000) ] − 1 = 31.61% 2.5 marks

EXAMINER’S COMMENT

Question Two (a)

The requirement here was for candidates to explain the three types of working capital policies
of an organization. Answers to this question demonstrated good understanding of working
capital policies.

Question Two (b)

This part of question 2 required candidates to determine the amount required in a given scenario.
This question was difficult for most candidates and few were able to gain average marks.

Question Two (c)

This part of question 2 required candidates to calculate average dividend growth rate. Most
candidates calculated the required average dividend growth rate correctly.

Page 11 of 19
QUESTION THREE

a. Investment appraisal for mining company versus municipal assembly

Mining company is a profit making company but municipal assembly is a not-for-profit

organization. Their investment appraisal objectives will be different

 Very few municipal assemblies’ will have capital investment with the view to making
financial returns. Even where this is done, the objective is not for distributing the profits
to shareholders
 On the decision about mutually exclusive projects, a mining company will prefer a
project with the highest NPV. But a municipal assembly will prefer the highest social
benefit over financial benefit
 A municipal assembly will be dependent on an interest rate set by government for its
investment appraisal analysis. But a mining company will use a commercial rate of
return which may be internally determined or by market forces.
 A municipal assembly may invest in public infrastructure and community development.
But a mining company may invest in noncurrent assets such as Plant and machinery,
research and development and advertising
 A municipal assembly will depend on cost-benefit analysis instead of financial analysis
for a decision on investment projects. But a mining company will depend on discounted
cash flow analysis that takes accounts of time value of money for its analysis
 A municipal assembly may go beyond an NPV analysis to use the total welfare analysis
which may include benefits not measurable in monetary terms. This may lead to
prioritising a negative NPV project. A mining company with a profit focus will not
accept a project with negative NPV
 Cost benefit analysis is considered superior to a municipal assembly where as a
discounted cash flow analysis is considered superior for a mining company which will
be profit focused.

(1 mark for each point up to a maximum of four (4) marks)

Page 12 of 19
 b. God is King

Years 0 1 2 3 4 5 6

Contribution 500,000.00 500,000.00 500,000.00 500,000.00 500,000.00 0.5mk

Fixed cost (170,000.00) (170,000.00) (170,000.00) (170,000.00) (170,000.00) 1mk

Taxable cash 330,000.00 330,000.00 330,000.00 330,000.00 330,000.00 1mk

flow

Tax (66,000.00) (66,000.00) (66,000.00) (66,000.00) (66,000.00) 2mks

Machine cost (800,000.00)

Installation (50,000.00)

Working (30,000.00) 30,000.00 1mk

capital

Net cash flow (850,000.00) 330,000.00 234,000.00 264,000.00 264,000.00 294,000.00 (66,000.00) 1mk

DF (20%) 1.000 0.870 0.756 0.658 0.572 0.497 0.432 1mk

PV (850,000.00) 287,100.00 176,904.00 173,712.00 151,008.00 146,118.00 (28,512.00) 1mk

NPV 56,330.00 0.5mk

Advise to management. Project has a positive NPV of GHS56, 550. It should therefore be
implemented 1 mark

Page 13 of 19
 c. Islamic finance

i. Mudaraba contract
This is a type of partnership contract where only one partner (rab al mal) contributes
finance and the other partner (mudarib) contributes skills and expertise. The partner who
contributes finance has no right to interfere in the day to day affairs of the partnership.
2 marks
ii. Musharaka contract
This is an equity financing contract for investment in business ventures or specific
business projects and consist of at least two partners called the mushasrik. The
mushariks jointly contribute capital and expertise in the business.
2 marks
iii. Murabaha contract
This is a deferred payment sales or an instalment credit sale usually for the purchase of
goods for immediate use. The seller therefore sells goods to the buyer, and the buyer
pay later by instalments.
2 marks

EXAMINERS COMMENT
Question Three (a)
The requirement here was for candidates to describe four (4) ways in which the investment
appraisal approach of a Municipal Assembly will differ from a mining firm. General
performance on this question was excellent though some few candidates failed to answer the
question asked and therefore received no marks.

Question Three (b)

Candidates were asked to calculate the net present value of a project and advise management
on whether to accept or reject the project. Majority of the candidates answered this part of the
question fairly well.

Question Three (c)

Candidates were asked to explain three (3) terms under Islamic finance topic. Most candidates
had no knowledge on Islamic finance topic in the syllabus hence provided incorrect
explanations to the terms.

Page 14 of 19
QUESTION FOUR
a. (i) Dinpa
Dinpa
Loan Amount (C) 300,000
Interest rate (r) 25%
No. of years (n) 5
Annuity (DF) 2.68928 or 2.689
Annual Instalment 111,554.02

(1 − (1 + 𝑟)−𝑛
𝐴𝑛𝑛𝑢𝑖𝑡𝑦 =
𝑟
(1−(1.25)−5
𝐴𝑛𝑛𝑢𝑖𝑡𝑦 = = 2.689 1 mark
0.25

𝐶
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑚𝑒𝑛𝑡 =
𝐷𝐹
300,000
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑚𝑒𝑛𝑡 = = 111,554.02 1 mark
2.689

Years Bal B/d interest Principal Instalment Balance c/d 1 mark

repayment
1 300,000 75,000 36,554.02 111,554.02 263,445.98 1 mark
2 263,445.98 65,861.49 45,692.53 111,554.02 217,753.45 1 mark
3 217,753.45 54,438.36 57,115.66 111,554.02 160,637.79 1 mark
4 160,637.79 40,159.45 71,394.57 111,554.02 89,243.22 1 mark
5 89,243.22 22,310.80 89,243.22 111,554.02 - 1 mark

i. (ii) Advantages of term loan over overdraft

 interest charged is not predictable, as it depends on a variable interest rate and on the
amount overdrawn on each day of the charging period
 the lender may not grant the entire amount requested, as changing financial situation of
the business will be taken into consideration
 overdrafts are repayable on demand, which may occur at a time when management are
not ready
 company may be forced to convert a hardcore overdraft into a loan term which can affect
capital structure especially where the preference for overdraft was for managing the
capital structure
 management will need to spend time strictly monitoring their accounts to ensure they
operate within the overdraft limit.

Page 15 of 19
  time will need to be spent preparing management accounts and monitoring compliance
with covenants
(1 mark for each point up to a maximum of 3 marks)

b. convertible bods
(i) 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 𝑥 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜; ₵100 = 20 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = ₵6
∴ 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = 20𝑥6 = ₵120 2 marks

(ii) 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚; 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑐𝑜𝑢𝑝𝑜𝑛 −

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑐𝑜𝑢𝑝𝑜𝑛 = ₵123
𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 = ₵120
∴ 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 = 123 − 120 = ₵3 2 marks

(iii) The share price is less than the bond market value. This will not be attractive to the
bondholders. The share price have to increase by at least 2.5% [(3/120) x100] for it to
be attractive to bond holders. 2 marks

c. Random walk theory

The random walk theory is based on the fact that share prices will reflect every available
information such that prices will alter when new information becomes available. The
assumptions include the following:

 All information about a company is available to all potential shareholders;

 The intrinsic value of shares will change to reflect new information available;
 All investors will act rationally;
 There will be no insider dealings.

(1.5mark for each point up to a maximum of 3 marks)

Page 16 of 19
EXAMINER’S COMMENTS

Question Four (ai)

The question required candidates to prepare repayment schedule for a company stating clearly
both the interest and principal payments. This part of question 4 was poorly attempted and most
candidates either had no marks or obtained very low marks.

Question Four (aii)

The requirement here was for candidates to state three (3) advantages of term loans over
overdraft facility. This question was well handled by almost all the candidates.

Question Four (b)

The requirement here was for candidates to determine debenture conversion rate, premium and
also comment on the possibility of bond holders converting for shares. Most candidates were
unable to answer the question and therefore had no mark.

Question Four (c)

The requirement here was for candidates to state two (2) assumptions underlying the random
walk theory. Most candidates were unable to provide the required assumptions and therefore
had no mark.

QUESTION FIVE
a. Interest rate and purchasing power parity
Interest rate parity is the method of predicting foreign exchange rate based on the hypothesis
the different between the interest rate in two countries should offset the difference between the
spot rate and the forward foreign exchange rate over the same period.
2 marks
Purchasing power parity is the rate theory that states that the exchange rate between two
currencies is the same in equilibrium when the purchasing power of currency is the same in
each country. 2 marks

Page 17 of 19
 b. Skytrian
Skytrain profit or loss
statement Krona rate GHS GHS
½ mark
Sales 600,000.00

less cost
1 mark
Instruments importation cost 2,100,000 7 300,000
½ mark
Shipping 50,000
½ mark
Bank transfer charges (GHS) 5,000
1 mark
Bank transfer charges (Krona) 10,000 5 2,000
½ mark
Total cost (357,000.00)
1 mark
Profit 243,000.00

c. Currency forward and futures contracts

 Currency futures is a standardized contract whereas forward contracts are customized
contracts.
 Currency futures contracts take place in regulated markets whereas forwards contracts
are traded over the counter.
 Currency futures contract are in foreign currency whereas forwards contracts are in
local currency.
 Currency futures have flexible closeout dates but forwards have fixed close out dates.
 Underlying transactions for currency futures take place at the spot rate but for
forwards the underlying transactions take place at the forward rate.
 Currency futures are cheaper than forward contracts.
(1 mark for each point up to a maximum of 5 marks)

d. I, me, and myself

(i) 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 (𝑟) = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓)

Where
𝑟𝑓 = 𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑒𝑡𝑢𝑟𝑛𝑠
𝛽 = 𝐵𝑒𝑡𝑎 𝑓𝑎𝑐𝑡𝑜𝑟 𝑜𝑓 𝑡ℎ𝑒 𝑠ℎ𝑎𝑟𝑒𝑠
𝑟𝑚 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑟𝑒𝑡𝑢𝑟𝑛
∴ 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 (𝑟) = 15% + 1.2(20% − 15%) = 21% 3 marks

Page 18 of 19
 𝐷
(ii) 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 𝑟

𝑊ℎ𝑒𝑟𝑒 𝐷 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑎𝑛𝑑 𝑟 = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛𝑠
10
∴ 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 0.21 = 47.62 2 marks

EXAMINER’S COMMENTS

Question Five (a)

This part of the question required candidates to explain interest rate parity and purchasing power
parity. Most candidates performed poorly on this question though some few candidates did well
in scoring the full marks available.

Question Five (b)

This required candidates to calculate the profit or loss on a given transaction. Answers to this
question were of mixed quality. Some candidates scored full marks on this question while few
also had difficulty in answering the question.

Question Five (c)

The part of the question required candidates to give five (5) distinguishing features of currency
futures contract and a forward contract. Most candidates performed very well on this question.

Question Five (d)

The final part of the question required candidates to calculate the return and value of given
shares. Majority of candidates performed very well on this question.

Page 19 of 19
 NOVEMBER 2016 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS & MARKING SCHEME

STANDARD OF PAPER
The standard of the Financial Management paper for this November 2016 sitting was
generally good from Examination standard perspective. It was also good from student’s
appreciation, understanding and answering of the questions perspective. It was a
professionally balanced paper both in terms of syllabus coverage and marks allocation.
The questions asked were a good spread across the subject areas and also covered well
both quantitative and non-quantitative aspects of the syllabus. This ensured that those
who passed the paper were well read and prepared across the entire syllabus which
was excellent
The questions appeared precise, unambiguous and measured up to the standard
expected at level 2 of the examination. No typographical errors were noticed and no
errors were found in the questions.

PERFORMANCE OF CANDIDATES
The performance of the students was a remarkable improvement over the recent past
sittings and the best performance in recent memory. The average pass rate was about
33% far better than the less than 10% pass experiences. This can be partially attributed
to improvement in the questions setting and moderations to ensure that they were
balance, precise and comprehensible by the students commensurate with the standard
expected at level two. It was further noticed that the improvement in performance and
pass rate was spread across all centers, including the out of Accra and Cape coast
centers, which in prior sittings recorded the worst performances.

The possible reasons for the improved performance were as follows:

 Standard paper at that level commensurate with the knowledge and expertise
expected of students at that level
 Some improvement in preparations by students as answers provided showed some
level of good preparation by the students
 Improvement in tuition services provided
 Improvement in knowledge by students on exam preparation and questions
answering techniques
 The good performance was across all centers even though not in same magnitude.
 There was no evidence of copying in the exams.
 The level of preparations appeared better as reflected in the content of the answers.
This showed improved preparation by the students to adequately answer the
questions. Basic Finance terms and terminologies were responded to quite well and

Page 1 of 18
 most answers provided exhibited some level of basic fluency in Finance
terminologies.

NOTABLE STRENTHGS AND PERFORMANCE OF STUDENTS

The 33% of students who did well exhibited the following strengths:
 Reading and understanding of the questions
 Well planned responses to the questions in line with the requirements of questions
 Very legible handwriting making reading and marking easier and better
 Well prepared and showed strengths in both quantitative and written questions
 Avoidance of mixing different answers to different questions and scattering of
answers across difference pages mixed with answers of different questions.
 The strengths spread better by more students in this sitting than the prior sittings
where it was limited to few students.
 Ability to think outside the box

Observed weaknesses demonstrated by students

 Some level of weak understanding of Finance principles by some students
 Poor exam preparation by some students who did not do well
 Failure by some students to comprehend the requirements of the questions
 Wrong numbering of answers to questions making it difficult for examiners
 Writing on areas not required by the questions
 Poor arrangement of answers to questions with answers to some questions scattered
across different pages haphazardly
 Poor handwriting and faded pens making reading and marking difficult for
examiners
 Remedies for observed weaknesses
 Improvement in preparation time by students before writing the paper

Page 2 of 18
FINANCIAL MANAGEMENT QUESTIONS

QUESTION ONE

a) Explain the term Agency problem in relation to a Public Limited Liability Company?
(2 marks)

b) As a Finance expert, explain THREE practical steps to manage agency problem in public
limited liability companies. (3 marks)

c) Profit maximization is the core objective of shareholders in Public limited Liability

Companies. Identify and explain THREE other non-financial objectives that can be
pursued by a Public limited liability Company. (3 marks)

d) Shareholders are risk-takers but Directors are risk averse. Explain THREE approaches that
corporate governance has identified for addressing conflict of interest between shareholders and
Directors. Reference can be made to Companies Act 1963, (Act 179)
(6 marks)

e) Explain THREE internal hedging methods that a company can use in order to minimise
translation risk and transaction risk. (6 marks)

(Total: 20 marks)

QUESTION TWO

a) Explain THREE causes each of the following situations;

i) Overcapitalised (3 marks)
ii) Overtrading (3 marks)

b) The liberalization of the downstream Oil and Gas sector in Ghana has created intense
competition among the oil marketing companies. SAP Petroleum Ltd is considering
relaxing its tight credit policy to boost sales in the light of the current market
development. The change in policy will result in an increase in average collection period
from 30 days (1 month) to 60 days (2 months). The review in credit policy is expected to
increase sales in each year amounting to 25% of the current sales volume.
Selling price per litre GH¢ 30
Variable cost per litre GH¢ 27
Current annual sales GH¢ 6,000,000

The required rate of return on investment is 28%. The 25% increase in sales will result in
additional stock level of GH¢250,000 and additional accounts payable of GH¢ 50,000.

Page 3 of 18
 Required:
Provide your expert advise on whether to extend or not to extend period to customers if:
i) All the customers take the longer credit of 2 months. (5 marks)
ii) Existing customers do not change their payment terms and only the new ones did?
(4 marks)

c) i) Explain the concepts stock split and scrip issue and identify the main difference
between the two. (3 marks)

ii) Explain why a company will embark on scrip issue? (2 marks)

(Total: 20 marks)

QUESTION THREE

a) Sakyiama Poultry Farms is considering purchasing a new incubator that will improve its
incubation efficiency to 90% as against the current 50%. The incubator, which is to be
purchased immediately will cost GH¢120,000. The incubator has a useful life of 4 years,
after which it would be sold for scrap at GH¢10,000. The current contribution of GH¢3
per day old chick will not change. The number of day old chicks sold at 12,000 units per
annum will increase by 80%. Fixed cost will be GH¢20,000 per annum. Sakyiama Farms
have after tax cost of capital of 12.5% and pays tax in the year in which profit is made at
a rate of 15% per annum. The farm is also entitled to capital allowance at 25% on
reducing balance.

Required:
i) Calculate the Net Present Value (NPV) and the viability of the investment.
(7 marks)
ii) Calculate the Internal Rate of Returns (IRR). (8 marks)

b) Two blue chip companies – Abu Ltd and Ada Ltd are seeking to raise funds from venture capital
to boost their production in order to satisfy demand for their solar powered refrigeration and air-
conditioning systems, which they developed through a joint venture. They have consulted you for
advise.

Required:
Explain FIVE conditions that a venture capitalist will consider in accessing an
application for funding. (5 marks)

(Total: 20 marks)

Page 4 of 18
QUESTION FOUR

a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the
board is for you to provide education and working solution to their foreign exchange
losses problem which your predecessor had no clue.

Your first task was to provide basic knowledge to the board on foreign exchange losses.
How will you explain the following?
i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)

b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the
following performance. The following information was made available to you:
Current market price per share (as at 31/12/15) GH¢ 10
Dividend per share 2015 GH¢ 1
Expected growth rate of dividend 20% per annum
The average market returns 27%
The risk free government rate 24%
The beta factor of Kaluu Ltd 1.4

Required:
i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model?
(3 marks)
c)
i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)

ii) A company enters into an agreement with a bank and it sells GH¢10million government bonds
with an obligation to buy back the security in 60 days. If the rate is 8.2% what is the repurchase
price of the bond? Assume 365 days in a year. (3marks)

(Total: 20 marks)

QUESTION FIVE

a) The annual demand for Praise Limited’s inventory is 10,500 units. The item costs GH¢400 a unit
to purchase. The holding cost for one unit for one year is 12% of the unit cost and ordering costs
are GH¢450 per order. The supplier offers a 2% discount for orders of 700 units or more and a
discount of 3% for orders of 950 units or more.

Required:
Determine the cost minimising order size of the company. (8 marks)

Page 5 of 18
b) Five years ago, Gasoto Ltd. issued 12 per cent irredeemable debentures at their par value of
GH¢100. The current market price of these debentures is GH¢94. The company pays corporation
tax at a rate of 30 per cent.

Required:
Calculate the company’s current cost of debenture. (3 marks)

c) Zeb Limited offers 2 percent discount to its customers who pay within ten (10) days. The
company normally collects its debt within thirty (30) days. Assume 365 days in a year.

Required:
Determine the cost of the discount to the company (3 marks)

d) Brothers Limited enters into a forward rate agreement (FRA) with Bank of Frica in which
Brothers Limited will receive a fixed rate of 8% for nine (9) months on a loan of GH¢1million.
Bank of Frica agrees to receive a nine (9) months LIBOR rate to be determined in nine (9)
months’ time on the loan principal.

Required:
Determine the results of the FRA and the effective loan rate if the spot rate for the
LIBOR in nine (9) months is:
i) 5%
ii) 10% (6 marks)

(Total: 20 marks)

Page 6 of 18
Relevant Formulae
Modified Internal Rate of Return
Value at Risk
The Fisher Equation:
Capital Asset Pricing Model

Ungeared (Asset) Beta

Gordon’s Growth Model

Bond Valuation

Miller and Modigliani (MM) Proposition 2 with tax

Weighted Average Cost of Capital

Purchasing Power Parity

Interest Rate Parity

International Fisher Effect

Black-Scholes Option Pricing Model

Put-Call Parity Relationship

Page 7 of 18
MARKING SCHEME

QUESTION ONE

a) Agency problem occurs when managers or management take decisions that are not
consistent with the objectives of shareholder value maximization. Contributors to
this agency problem are: divergence of ownership and control, goals of managers
differing from those of share holders because of personal interest and asymmetry
of information between managers and shareholders. (2 marks)

b) The following can be used to manage or resolve agency problem

 Use of performance related reward scheme: in the form of pay and bonuses
based on satisfactory performance of managers in delivering shareholder value
 Executive share option scheme: where managers or executives are allowed to
buy the shares of the company at a fixed price within a particular period. The
option will only have value if the market price is better than the price they will
pay for exercising the option. This will encourage goal congruence between
managers and shareholders.
 Threat of firing or dismissal: Managers or directors can be forced out by the
shareholders if they are unhappy with their performance through shareholder
meetings. This method can put pressure on managers or directors to perform.
 Key Market participants like institutional investors such as fund managers,
pension houses, insurance companies who have larger shareholdings can
exercise that to push managers to perform or be voted out.
 Monitoring and control of managers performance through the use of external
and internal auditors, Board committees and review consultants.
(Any 3 points for 3 marks)

c) The following are other objectives:

 Staff motivation
 Top service to customers
 Growth
 Market leadership in research and development
 Social responsibility
 Environmental sustainability
 Diversification purposes etc.
(Any 3 points for 3 marks)

Page 8 of 18
d) Managing conflict of interest
The main approaches are discussed below

 Alignment of management goals with the shareholder value maximisation. This applies to
the form of compensation/rewards provided for the Directors. It should be such that their
actions will create a win-win situation for both the Directors and the shareholders. This
process leads to goal congruence where the goals of the Directors that can influence them to
pursue their personal interest are aligned with the goals of the shareholders.

 Various corporate governance controls also push the Directors to act in the interest of
shareholders. Shareholders are responsible for the appointment of Directors, and the
Directors in turn appoint their managers. Just as Directors can fire nonperforming
managers, the shareholders can also replace the Directors if they consider them to be
nonperforming. Again monitoring of management performance through periodic audit
(internal and external) and other attestation arrangements will enable weaknesses in
systems to be identified and steps taking to address those weaknesses.

 Provide a practical framework of reference for reviewing and modernising existing policy
solutions in line with good practice. Promoting a culture in which conflicts of interest are
properly identified and resolved or managed.
(3 points for 6 marks)
e)
 Translation risk is best managed by using matching. For example, in purchasing an asset in
a foreign country, a company should raise the funds for the purchase in the foreign currency
so both the asset and liability are in the same currency. There are a number of ways to hedge
transaction risk internally. Matching, for example, could mean paying for imports in the
same currency that a company invoices its exports in.
 Alternatively, a company could invoice customers in the domestic currency and find a
supplier which does the same. The problem with this method, though, is that the company
may lose foreign sales and also restrict the potential suppliers it can purchase from.
 Companies can also manage transaction risk by leading and lagging payments according to
their expectations of exchange rate movements.
(6 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
This question was a typical essay question that tested the student’s knowledge and
understanding of agency problem in governance in the Finance world and how to
manage that to achieve optimal results for stake holders. It also tested students on other
non-financial objectives of the corporate bodies and how to hedge or manage currency
risk in the globalised finance world. The question was well spread from (a) to (e).

Page 9 of 18
Almost every student attempted this question and was one of the questions that
received average to excellent answers from students and one of the best answered
questions. Performance of the students was good.

QUESTION TWO

(a)
(i) Over capitalization refers to a situation where a company has more or excess capital
at its disposal than what is required for its normal and optimal operation or utilization.
When a company has issued more debt and equity than its assets are worth. An
overcapitalized company might be paying more than it needs to in interest and
dividends. Reducing debt, buying back shares and restructuring the company are
possible solutions to this problem. (3 marks)

(ii) Overtrading is a situation where a company or firm has insufficient or inadequate

cash or near cash resources at its disposal to conduct its operations due to rapid growth.
The indicators of overtrading are:
 High utilization of trade credit with large creditor positions
 Large turnovers with no corresponding increase in cash or cash equivalents
 Funding or liquidity challenges etc (3 marks)

b)(i) All customers takes the offer

Extra Profit:
Contribution Sales Ratio = (30-27)/30 = 3/30 = 10%
Increase in sales revenue: 25% x 6,000,000 = 1,500,000
Increase in contribution = 10% x 1,500,000 = 150,000
Extra investments if all accounts or customers received 60 days ( 2months):
Average accounts receivable after increase sales = 2/12 x 7,500,000 = 1,250,000
Less current accounts receivable (1/12 x 6,000,000) = 500,000
-------------------
Increase in accounts receivable 750,000
Increase in inventories 250,000
--------------------
1,000,000
Less increase in accounts payables 50,000
--------------------
950,000
Return on investment = 150,000/ 950,000 = 15.8% (5 marks)

Page 10 of 18
(ii ) Extra investment if only new accounts receivables take the 2 months:
Increase in accounts receivables = 2/12 x 1,500,000 = 250,000
Increase in inventories = 250,000
-------------------
500,000

Less increase in accounts payables 50,000

--------------
450,000
---------------------
Return on investment = 150,000/ 450,000 = 33.33% (3 marks)
The policy is worthwhile if the existing customers stick to the 1 month and new
customers or accounts take the 2 months. The return on the latter is 33.33% which has
crossed the required rate of return of 28%.
Decision or advice (1 mark)
c)
i) A stock split simply divides existing outstanding shares held by shareholders into
multiple shares. i.e. if you own one share before a 2-for-1 split, you will own 2 shares
after. A scrip issue works in almost the same way except that instead of having your
shares split into 2, the company issues you one additional fully paid share free of charge
so that you will also own 2 shares after the bonus issue. (3 marks)

ii) Why a company will embark on scrip issue

One of the major reasons why companies declare bonus issues is that a higher number
of shares improves float and liquidity and thereby traded volumes of the stock. A lower
price also makes the stock seem more affordable to small retail investors, who might
otherwise give it a miss at high price levels. Another aspect of a bonus issue is that it
reflects the confidence of the company in its ability to service a larger equity base. Thus,
bonus issues are said to be a good signaling mechanism on the company’s capacity to
deliver future benefits to shareholders in terms of increased dividend. (2 marks)

(Total: 20 marks)
EXAMINER’S COMMENTS
This question consisted (a) to (c) portions. The (a) aspect was mainly essay on
overcapitalisation and over trading testing student’s knowledge on the causes of the
two. Most students answered the question more from their symptoms than their causes
but some students were able to understand and responded to the requirements of the
question. They generally were able to explain the two but struggled on the causes. It
was generally an average performance.
The (b) aspect was decision making question on working capital management. It
focused on debtor’s management and financial impact in terms of required rate of

Page 11 of 18
 return on investment from increasing debtor payment days from 1 month to 2 months
with the associated increase in sales volumes.
Students generally had a poor understanding of the questions and struggled to
compute the various variables required to answer the question satisfactorily. It was one
of the poorly answered questions and most candidates obtained poor marks. The few
who got it right scored good marks.
The (c) part of the question tested students on stock split and scrip issue and the core
reason for a company embarking on scrip issue. This was straight forward question and
was widely attempted by students.

Overall it was poor to average performance.

QUESTION THREE

a) Sakyiama farms
(i) Investment appraisal

Years 0 1 2 3 4 Marks

Cost 120,000.00 90,000.00 67,500.00 50,625.00 37,968.75

Capital allowance 30,000.00 22,500.00 16,875.00 12,656.25 0.5mk

Tax gain 4,500.00 3,375.00 2,531.25 1,898.44 0.5mk

Additional gain (37,968.75-

398.44 0.5 mk
10,000)x15%)

Contribution
0.5 mk
( 64,800.00 64,800.00 64,800.00 64,800.00

Fixed Cost (20,000.00) (20,000.00) (20,000.00) (20,000.00) 0.5mk

Cash flow before tax 44,800.00 44,800.00 44,800.00 44,800.00 0.5mk

Tax (15%) (6,720.00) (6,720.00) (6,720.00) (6,720.00) 0.5mk

Tax gain 4,500.00 3,375.00 2,531.25 1,898.44 0.5mk

Additional gain 398.44 0.5mk

Cost of incubator (120,000.00) 0.5mk

Page 12 of 18
Scrap value 10,000.00 0.5mk

0.5mk
Net cash flow (120,000.00) 42,580.00 41,455.00 40,611.25 50,376.88

Discount factor (12.5%) 1.000 0.889 0.790 0.702 0.624 0.5mk

0.5mk
Present value (120,000.00) 37,848.89 32,754.57 28,522.58 31,450.04

Net Present value 10,576.07 0.5mk

Total for this is 7 marks

(ii) IRR
Net cash flow (120,000.00) 42,580.00 41,455.00 40,611.25 50,376.88 1 mks

Discount factor (17%) 1.000 0.855 0.731 0.624 0.534 1 mark

Present value (120,000.00) 36,393.16 30,283.44 25,356.47 26,883.62 1 mark

Net Present value (1,083.31) 1 mks

12.5

17

(1,083.31)

4 marks

Note: Candidates who use any rate above 12.5% for “b” and follow the correct process should
get full marks even if the IRR is not equal to 15.67% Total 8 marks

Page 13 of 18
 (b) Venture capitalist
Venture capitalist will evaluate proposal for funding based on a number of criteria
including the following
 Nature of the company’s products
The products of the company should enable it generate adequate sales and profits
that are sustainable for it to be attractive to venture capital investment.
 Expertise in production
Technical ability should be demonstrated through efficient production and value
driven skills and competencies.
 Expertise in management
Management should demonstrate commitment, skills, and experience in promoting
the objectives of the organization.
 The market and competition
The company’s proposal should demonstrate that it has a competitive strategy to
maintain and expand its market share
 Future profits
The prospects of the company in generating future profits are realistically expressed
in its business plan and proposal.
 Board membership
The company should have a board of directors who will take decisions and consider
the interest of the stakeholders
 Risk borne by existing shareholders
Significant part of the company’s funding is from its owners who also bear the major
part of the company’s risk
(Any 5 points for 5 marks)
(Total: 20 marks)

EXAMINER’S COMMENTS
This question was a blend of comprehensive investment appraisal and decision making
on the (a) i and ii part and essay question for the (b) on consideration by venture
capitalist in financing a project or business.
A lot of pre working was required on the (a) part and involved a lot of calculations for
both NPV and decision and Internal Rate of return calculation. This was one of the
questions students spent a lot of time on. Only few brilliant students got it right here as
most students generally attempted the question based on their own understandings to
get some few marks. It was one of the worst answered questions in the paper.
The (b) aspect also did not get a coherent response from the students but the students
thought generally outside the box on what was expected and answered appropriately. It
received varied answers from the students and almost every student attempted the
questions and provided their responses based on their understanding. It was fairly well
answered

Page 14 of 18
QUESTION FOUR

a)
(i) Foreign exchange risk is the risk of changes in the foreign exchange rate or the value
of a currency. The level of change or movement cannot be determined with certainty
making any counterparty with exposure in that be exposed to the market volatility or
uncertainty. (2 marks)
(ii)Transaction exposure refers to the gains or losses made on foreign exchange
transactions due to the changes in the exchange rate between the transaction date and
the payment or settlement date if the exposure or transaction is unhedged. (2 marks)
(iii)Translation risk refers to the movement in values either gains or losses of the
balance sheet due to the consolidation of the assets and liabilities into a reporting
currency from various currencies. (2 marks)
(iv)Economic exposure refers to the long term changes in the value of a foreign firm
due to the unexpected changes in the exchange rate movements. (2 marks)

b) Estimated cost of equity using Gordon Growth Model

(i) Ke = do(1+g)/po + g
Where do = 1
Po=10
g= 20%
= 1(1+0.2)/10 + 0.2
= 0.32 = 32% (3 marks)

Using CAPM
(ii ) Ke = 0.24+ 1.4(0.27-0.24)
= 0.282 = 28.2%
(2 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
Question 4 was also a blend of essay and calculation question. The (a) aspect covered (i)
to (iv) mainly on types of exchange rate risk and was of the well answered areas by
most students and performance was generally satisfactory.
The (b) and (c) aspects which tested students’ knowledge on computation of cost of
equity from both dividend growth model approach and Capital assets pricing model
perspective were one of the best answered areas in the exam. The requirements of the
questions were well understood and the students answered precisely to that scoring the
maximum marks in most cases.

Page 15 of 18
The (c) aspect which covered repos and reverse repos and calculations were averagely
answered. On overall basis question (4) was one of well attempted questions by the
students.

QUESTION FIVE

(a) The EOQ ignoring discounts

2C 0D 2 x 10500 x 450
EOQ = = =443.71 units or 444 units
H 400 * 0.12
GHC
Purchases (no discount) 10500 x GHC 200 4,200,000
Holding cost (444/2) units x 12% x 400 10656
Ordering costs (10500/444)*450 10702.27
Total annual costs 4,221,358
(b) With a discount of 2% and an order quantity of 700 units costs are as follows:
Purchases 10500*400*0.98 4,116,000
Holding costs (700/2 *0.12*400*0.98) 16464
Ordering costs (10500/700*450) 6750
Total annual costs 4,139,214
(c) With a discount of 3% and an order quantity of 750 unit cost are as follows:
Purchases 10000*400*0.97 4,074,000
Holding costs (950/2 *400*0.12*0.97) 22,116.00
Ordering costs (10500/950 *450) 4973.68
4,101,089.7
The cheapest option is to order 950 units at a time
(8 marks)
b) Company’s current cost of debenture
Kd = 12/94 = 12.8% Kd (after tax) = 12.8 × (1 – 0.3) = 8.96% (3 marks)

c) Cost of discount to the company

 365 
 
 100   3010 
  1
 100  2 
 365 
 
 100   20 
   1 = 44.59%
 98 
(3 marks)

Page 16 of 18
d)

(i) 5%

Brothers pays
22,500

Effective loan rate

FRA payment 22,500

Loan interest 37,500

Total 60,000

Effective rate is 8%

(ii) Settlement
10%
Bank of Frica pays
15,000

Effective loan rate

FRA Receipt (15,000)

Loan interest 75,000

Total 60,000

Effective rate is 8%

Page 17 of 18
EXAMINER’S COMMENTS
The (a) aspect required comprehensive calculations and decision making on various
discount levels to achieve cost minimising order levels.
The (b) aspect tested students on their ability to calculate the cost of debenture of a
company while the (c) examined them on the determination of cost discount to
company for offering discounts to debtors who paid within 10 days.
Goods answers were generally received from the students.

The questions were generally standard commensurate with the level and students
answers to questions showed improvement over the last few sittings.

Page 18 of 18
 NOVEMBER 2017 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

STANDARD OF THE PAPER

The standard and quality of the Financial Management paper appeared normal for that
level. The questions were well distributed in terms of syllabus coverage as well as the
quantitative and theory aspects. The questions were well spread across the subject areas
and also covered well both quantitative and non-quantitative aspects of the syllabus
The questions also appeared straight forward for students to understand and answer. No
ambiguous questions were noticed to pose challenges to well-prepared students
understanding. It was also observed that generally no sub-standard questions were set in
the paper and all questions were considered normal and standard for that level.

Mark allocations appeared generally fair relative to the nature of questions and expected
answers. Where questions set had alternative approaches to answering the questions,
alternative solutions were provided through the coordination process to cover students
answering from alternative approaches.

PERFORMANCE OF CANDIDATES
The performance of the students in the paper was generally below expectation relative to
the nature of the questions and below the average pass rate in the May examination. The
overall pass rate was 28.21% compared to the over 30% pass rate in the previous sitting.
This was however still better than the general historical pass rate of below 10%
The possible reasons for the below expectation performance were still valid:
 Poor preparations by students as answers provided clearly showed lack of or
inadequate knowledge of the subject area in some cases
 Poor tuition services provided especially out of Accra centres
 Failure of students to thoroughly study and use ICA syllabus and content manuals
 Poor quality and background of students who wrote the paper vis a vis the very high
standard of the questions and expected standard at that level
 Poor knowledge by students on exam preparation and questions answering
techniques
 Limited access to study materials especially the out of Accra centres
 The below expectation performance were still noticed to be more visible in centres
outside Accra

NOTABLE STRENGTHS & WEAKNESS OF CANDIDATES

The 28.21% students who did well exhibited the following strengths:
 Reading and understanding of the questions
 Well planned responses to the questions in line with the requirements of questions
 Very legible handwriting making reading and marking easier and better
 Well prepared and showed strengths in both quantitative and written questions

Page 1 of 25
 Avoidance of mixing different answers to different questions and scattering of
answers across difference pages mixed with answers of different questions.
 The strengths were noticed to be improving compared to the historical rates
 Ability to think broadly manifesting the level of thorough research in the study.

Observed reasons of the strengths:

The following were still considered valid for the strengths
 Improvement in preparation for the paper
 Improvement in the Knowledge of how to answer questions
 Sufficient study of the entire syllabus and covering both quantitative and essay areas
of the syllabus
 Good background knowledge and experience in Finance
 Proper tuition, adequate study materials, research, reading and practice towards the
exams.

The strengths can be enhanced by:

 By updating and improving quality of study materials
 By enhancing the quality of tuition
 By teaching exams questions and answering techniques as part of the revision process
prior to the exams after tuition
 Providing more tuition centres across the country
 Teaching and coaching students how to think outside the box in difficult situations
and in questions that require general application of knowledge

Observed weaknesses demonstrated by students

 Poor understanding of Finance principles
 Poor exam preparation
 Failure to comprehend the requirements of the questions
 Wrong numbering of answers to questions making it difficult for examiners
 Writing on areas not required by the questions
 Poor arrangement of answers to questions with answers to some questions scattered
across different pages haphazardly
 Poor handwriting and faded pens making reading and marking difficult for
examiners.

Page 2 of 25
QUESTION ONE

a) Directors usually want to focus on factual matters and concrete actions. They deal with rules,
regulations, and compliance standards to ensure adherence to the law. They mostly measure
company’s performance in financial terms with secondary consideration of other metrics.

Required:
i) Briefly explain and identify FOUR examples of non-financial objectives of private
companies. (6 marks)
ii) Discuss and identify examples of the effect of these non-financial objectives on the
achievement of the financial objectives of companies. (4 marks)

b) A private company is desirous of obtaining quotation on the Ghana Stock Exchange.

Required:
Set out;
i) The likely reasons for seeking quotation (4 marks)
ii) The prior considerations, and (3 marks)
iii) The methods of marketing the security (3 marks)

(Total: 20 marks)

QUESTION TWO

a) One of your clients has seen many references to the “Cost of Capital” in the Business and
Financial Times and has asked you to give him some guidance on what would be an appropriate
figure for his organization-Zaytuna Ltd. The following information are available for Zaytuna
Ltd.

Existing capital structure

GH¢‘000
Issued ordinary shares- - 12,000,000 12,000
Retained earnings 4,000
6% Preference shares 2,000
9% Debenture repayable 2018 6,000
24,000
i) 9% Debenture
Issued in 2008 at par
Current price GH¢ 92
A similar issue if made now would require to be at GH¢ 90

ii) Preference Shares

Preference shares have a par value of GH¢1 and were originally issued at 92p per share
Current price 43p
A similar issue if made now would require to be 40p per share

Page 3 of 25
iii) Ordinary Share
The market price of an ordinary share is GH¢7.00
GH¢ 6 million in dividends were paid this year which represented 75% of earnings
Earnings are expected to grow at an annual rate of 5%
If new ordinary shares were issued now, costs incurred would represent 25p per share and a
reduction below market value of 50p per share would also be made.

iv) Corporate tax rate is 25%

Required:
Calculate Zaytuna Ltd Weighted Average cost of capital. (15 marks)

b) Many small firms encounter a lot of problems in obtaining funds from the entire financial
market to run their businesses. This problem has always accounted for their low performance
in business.

Required:
What problems do small firms encounter in their efforts to raise capital in the Ghanaian
financial markets? (10 marks)

(Total: 25 marks)

QUESTION THREE

a) Wax Ltd is a very large company employing over 20,000 people. Its business covers ten
activities including food processing, warehousing, clearing and forwarding. Each activity is
run as a division. Performance and hence the rewarding of management is based on divisional
Returns on Investment (ROI).

Required:
i) Explain FOUR advantages that may accrue to Wax Ltd for using ROI to measure performance.
(4 marks)

ii) Explain THREE problems under the use of ROI and what safeguards can be applied to
minimize such problems. (6 marks)

b) The Gomoa Chemical Limited has a capital budget for 2018 of GH¢1,000,000
The following capital investment proposals are submitted to the capital budget committee.

PROJECT PROFITABILITY INDEX OUTLAY

1 1.2 200,000
2 1.18 200,000
3 1.17 100,000
4 1.10 300,000
5 1.15 200,000
6 1.13 200,000

Page 4 of 25
 7 1.19 400,000
8 1.21 100,000
9 1.22 100,000
10 1.16 100,000

The company’s cost of capital is 5%

Projects 2 and 8 are mutually exclusive: Projects 1 and 5 are mutually dependent

Required:
As the chairman of the budget committee, which projects should the committee choose?
(15 marks)

(Total: 25 marks)

QUESTION FOUR

a) “Before the credit crunch tenanted-pub, firms borrowed cheaply in order to buy up back street
boozers. But the debt crisis and the resulting slowdown have left the tenanted-pub industry
nursing the hangover from hell.” Financial times November 27/28 2010.

Required:
Explain the term “overtrading” and in your answer show how the financial backers could
diagnose (or misdiagnose) the main symptoms of this condition, the various possible causes
of such symptoms, and how firms could overcome this situation. (8 marks)

b) Asuo Ltd manufactures only one product, planks. The single raw material used in making
planks is the dint. For each plank manufactured, twelve dints are required. The company
manufactures 150,000 planks per year and that demand for planks is perfectly steady
throughout the year. It costs GH¢ 200 each time dints are ordered, and that carrying costs are
GH¢8 per dint per year

Required:
i) Determine the economic order quantity of dints. (3 marks)
ii) What are total inventory costs for Asuo (carrying costs plus ordering costs)? (2 marks)
iii) How many times per year would inventory be ordered? (2 marks)

(Total: 15 marks)

Page 5 of 25
QUESTION FIVE

Paul and Tony Reid are the owners of LHW Ltd., publishers of “Luxury Homes of the World”.
As with similar pushers they are currently experiencing difficult market conditions. Paul
wishes to sell his share of the business to Tony to pursue other interests. Paul feels their
business has a “long term value” not captured by current market values. Paul and Tony wish
to have their business “property valued” so a “fair” buyout price can be agreed.

LHW Ltd: Balance Sheet as at 31 December 2016

Fixed Assets GH¢ million GH¢ million

Land and Buildings 2.5

Plant and Machinery 4.5
Fixtures and Fittings 1.5
Motor Vehicles 0.5
9.0
Current Assets
Stocks 1.1
Debtors 2.5
Cash 0.2
Prepayments 0.1
3.9
Creditors: amount payable within one year
Creditors 2.4
Taxation 1.5
Bank Overdraft 0.1
4.0
Net current assets (0.1)
Total Assets less current liabilities 8.9
Creditors: amount payable after one year
10% Debentures 2022 (5.0)
Deferred Taxation (1.3)
2.6
Financed By:
Ordinary shares of 10 pesewas 1.0
Share Premium 1.0
Retained profits 0.6
2.6
Net profit after tax and interest payments but before dividends was GH¢250,000 and the annual
dividend was GH¢100,000 for the year ended December 31 2016.

Covenants in the debentures require that a change in ownership of LWH would result in the
redeeming of its debentures. They must be redeemed at “fair market value” based on the yield
on comparable bonds, which is currently 8% p.a. The semi-annual coupon has just been paid
with 10 more due before the bond would mature in 2022.

Page 6 of 25
 Paul and Tony estimate that 20% of LWH’s debtors are likely to be irrecoverable but feel that
current market conditions will improve and that over the next three years earnings should
increase by 5% per annum.

Independent valuations state that the current realisable values of the company’s fixed assets
are:
GH¢ million
Land and Buildings 2.0
Plant and Machinery 4.0
Fixtures and Fittings 1.2
Motor Vehicles 0.35
7.55

For a firm similar to LHW Ltd with similar growth expectations but which is quoted on the
stock exchange, the Price Earnings (P/E) ratio was 14 times and its gross dividend yield was
10%.

Required:
a) Given the above information, estimate the value per share of LHW Ltd. using:
i) The net asset (liquidation) basis
ii) The P/E basis
iii) The dividend yield basis (assume with no growth) and
iv) The dividend yield basis (assume with growth)
(12 marks)

b) Explain the differences between standard deviation and beta and when each is an appropriate
measure of risk in a portfolio. (3 marks)

(Total: 15 marks)

Page 7 of 25
 SOLUTION TO QUESTIONS

QUESTION ONE

a)
i) Non-financial objectives of private companies
The maximisation of long term shareholder wealth should be the objective of all profit
seeking private companies. Often companies try to achieve this through a series of
primary financial objectives. In addition to these primary financial targets even profit
seeking private companies often have other secondary non-financial targets.
Non-financial objectives could be aimed at:
 The welfare of employees. Examples of this could be health and safety in the work
place, social and recreational services, the provision of accommodation or other
services and pay and perquisites beyond what might be deemed necessary to attract
and hold the appropriate staff.
 The welfare of management. Examples of this could be excessive pay and perquisites,
“empire building” or increasing market share by either organic growth or through
mergers and acquisition beyond what is in the best interests of shareholders for the
benefit of management or not taking on risks that would be in the interests of
shareholders but could jeopardise the survival of the firm and hence the welfare of
the management.
 The welfare of society. Examples of this could be acting in an environmentally
sustainable way, not testing products on animals, respecting human rights, being a
“good neighbour” and contributing to the local economy / community.
 The provision of a service. Examples of this could be providing a service which could
not be justified on purely profit grounds such as assisting access to their products for
the disabled or those in remote areas.
 The fulfilment of responsibilities towards customers and suppliers. Examples of
this could be excellent customer service or only dealing with “Fair Trade” suppliers.
 Technology / quality improvements. Many technology and engineering companies
are said to spend more time and effort on improving the technical aspects of their
product or service than in maximising their commercial value.
 Market leadership
 Growth
(1.5 marks for each non-financial objectives= 6 marks)

ii) The effect of non-financial objectives on the achievement of the financial

objectives of companies can include:

 By trying to improve health and safety in the work place, social and recreational
services, the provision of accommodation or other services and pay and
perquisites beyond what might be deemed necessary to attract and hold the
appropriate staff will increase costs and hence could reduce profit and dividend
growth. However the contrary is not always advisable either. Not following

Page 8 of 25
 acceptable health and safety standards or paying below minimum acceptable or
legal standards either in the customers markets or even where the product /
service is sourced in for example a third world country can be advantageous in the
short term. However it is possible that this could lead to de-motivated employees
and angry customers. If the company’s reputation suffers attracting and keeping
customers will be more difficult. Thus in the longer term this could hinder
achieving the financial objectives of companies.

 It would be hard to imagine how excessive pay and perquisites could be in the
best interests of shareholders. Thus this would be expected to reduce profit and
dividend growth. Similarly while management might argue that increasing
market share or increasing the size of the company by either organic growth or
through mergers and acquisition might be good for the shareholders this is often
not the case, (as often witnessed by the fall in the share price of a predator firm
when it announces it intends to engage in the takeover of another firm). This can
lead to earnings per share and dividends per share falls even though total profit
and dividends may rise.

 Not taking on risks would be expected to reduce profit and dividend growth and
would not be in the interests of shareholders unless it was argued that financial
distress costs are higher than is usually estimated in finance theory.

 Most firms now accept that they everyone has a part to play in ensuring
sustainable development and reducing their impact on the environment. Also
many firms choose to help society in many other ways too such as contributing to
the local economy / community not engaging in illegal activities such as illegal
pollution or bribing local and national officials. This could increase costs,
particularly in the short term. Hence it could reduce profit and dividend growth.
However it is possible that this could lead to increasing the reputation of the
company. This could lead to better motivated employees and again attracting and
keeping customers could be easier. Thus in the longer term this could be good for
the achieving the financial objectives of companies.

 Often firm provide a service such as assisting access to their products for the
disabled or those in remote areas. In many cases this is done purely to fulfil
statutory obligations but often it is done for “humanitarian” reasons too. This
would be expected to reduce profit and dividend growth.

 While in the short term getting around these regulations might appear to be a good
idea, should this be exposed, this legal but “unethical” behaviour might do
irreversible damage to a company’s reputation. Hence providing such services
could be interest of achieving the financial objectives of companies.

Page 9 of 25
  Offering excellent customer service or only dealing with “Fair Trade” suppliers
and other form of “ethical behaviour” can increase costs and hence could reduce
profit and dividend growth.

 However a reputation for always acting ethically could also lead to better
motivated employees. And if the company’s reputation improves, attracting and
keeping customers will be easier. Thus in the longer term this could be good for
the achieving the financial objectives of companies.

 Perhaps some technology and engineering companies might be spending more

time and effort on improving the technical aspects of their product or develop new
technologies that will improve the environment rather than spending time in
maximising shareholder wealth. However once again it is possible that this could
also lead to better motivated employees. And if the company’s reputation
improves, attracting and keeping customers will be easier. Thus in the longer term
this could be good for the achieving the financial objectives of companies
(Any 4 points for 4 marks)

b)
i) The likely reasons for seeking a quotation are listed below:
 To provide an immediate basis of valuation for the share and a market in which they
can be readily exchanged for cash.

 A quotation gives access to the savings of the public, when a company wishes to
recruit further capital for expansion.

 Amalgamation between companies is easier if part of the price to be paid is in shares,

quoted in a stock exchange. The fact that shares of the enlarged company are
marketable will facilitate the merger.

 After a quotation, the shareholders have a ready market for their shares. They can
exchange them for cash or use them more easily as a form of security.
(4 points for 4 marks)

ii) The prior considerations to obtaining a stock exchange quotation are as follows:
 The company must meet the requirements of the Ghanaian Stock Exchange.
Depreciation must have been sufficient in the past, and the accounts must have been
drawn up in a proper manner.
 The records of the past profits must be such that the public will be eager to invest in
the company. There must be a degree of certainty that profits will continue at or above
this level into the future. Consideration must be given to the fact that a more generous
dividend policy will have to be pursued in the future.

Page 10 of 25
  Before obtaining a quotation the board must consider the best method to bring the
Firm to the market, how much money to raise by the issue, the price at which the offer
is made to the public, and whether the offer is to be underwritten.
 The interest of the present shareholders must be considered. Thought must be given
as to whether they can maintain control after the issue. The assets of the company
must be revalued, and the surplus distributed as bonus shares.
 The type of new capital to be raised. The pros and cons of debentures, preference and
ordinary shares must be considered.
(Any 3 points for 3 marks)

iii) The methods of marketing a company are as follows:

 Public issue by prospectus: This is a direct issue to the public by means of prospectus
and advertisements detailing the number, class and price of the shares offered.
 An offer for sale: This is made by an issuing house to the public, of the shares which
it has previously bought from the owner of the business. Sometimes the owner offers
the shares on his own behalf.
 Offer for sale by tender: This method, which has been used on a number of occasions
in recent years for the issue of ordinary shares is similar to the offer for sale, except
that the issuing house (instead of offering the shares at a fixed price) invites the public
to send in tenders at a fixed price) invites the public to send tenders for the shares at
or above a minimum price, stating the maximum number of shares they would take.
In the light of the tenders received, the issuing house then fixes a price (the striking
price) at which the shares will be allotted.
 A Placing: This occurs when shares brought onto a Stock Exchange for the first time
are sold privately. A stock broker or issuing house may arrange for the issue to be
taken up by the clients or contracts.
 An Introduction: This is not a method of raising new capital, but of getting permission
to deal, i.e. introducing the shares of a small company to the market.
(Any 3 points for 3 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
This was an easy or theory question for (a) and (b) with sub questions under each.
Students were expected to explain only 4 non-financial objectives and their effects on the
financial objectives on the (a) part and the (b) part centred on the listing on the stock
exchange market.
This was straight forward question requiring straight forward answers.
Almost every student answered this question and the general performance of students
appeared satisfactory. This question contributed to the pass rate of the students who
passed the paper.

Page 11 of 25
QUESTION TWO

a) Note: Students will be awarded marks based on the cost of capital as determined by
them. The following calculations will be relevant to this.

Debentures
coupon rate
Marginal cost after tax = (I - tax rate)
proceeds of current issue

9
= (1 – 0.25)
90
= 7.50%

ALTERNATIVE SOLUTION

540,000 (1-0.25) X 100

5,400,000
= 0.075 X 100
=7.5%

(3 marks)
Preference shares
coupon rate
Marginal cost = proceeds of current issue

6
= 40

= 15%

ALTERNATIVE SOLUTION
= 120,000 X 100
800,000
= 15%

(3 marks)
Issue of ordinary shares
Dividend per share
Marginal cost = + growth rate
net proceeds of issue

50
= + 0.05
625

= 13%

ALTERNATIVE
50 + 0.05
700 –(50+25)

Page 12 of 25
 = 13%
(3 marks)

Cost of retained earnings = dividend yield + growth rate

50
= + 0.05
700

= 12.1%

Weighted average marginal cost of capital

Source of Capital Component

finance structure Cost Weighted
GH₵ 1 Weight % cost
million
Ordinary shares 12 0.50 13.0 6.50
Retained earnings 4 0.17 12.1 2.06
Debentures 6 0.25 7.5 1.88
Preference shares 2 0.08 15.0 1.20
24 1.00 11.64
(3 marks)

ALTERNATIVE SOLUTION
WACC

Source of Capital Component

finance structure Cost Weighted
GH₵ 1 Weight % cost
million
Ordinary shares (6.25@12m) 75 0.923 13.0 12.0
Debentures (0.9 @ 6m) 5.4 0.067 7.5 0.50
Preference shares (0.4 @2m) 0.8 0.01 15 0.15
TOTAL 81.2 1.00 12.65

WACC formula can also be used to arrive at the 12.65%

b) Small firms encounter the following problems in their efforts to raise capital in the
Ghanaian financial market.
 The high cost of obtaining a quotation on the stock market. For most small forms a
quotation has become impracticable.

Page 13 of 25
 Large firms are better known and provide more financial information than smaller
firms.
 The accounting system in large firms are more sophisticated and are able to provide
a greater quantity of more reliable information which can be incorporated into annual
reports or profit forecast.
 Investments in larger companies are more easily marketable.
 The smaller business will find it particularly difficult to attract venture capital.
 Small forms tend to lack the financial expertise to prepare adequate cash flow
projections or proper forecasts.
 The cost of finance to small firms will probably be higher than that for large business.
In order to attract capital in the first place, the small firm may be forced to pay a
greater rate of interest.
 Some governments supported schemes (e.g., agricultural loan guarantee scheme)
specify minimum qualifying levels which exclude the smaller firms.
(Any 5 points for 10 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
This question covered two aspects namely weighted average cost of capita (WACC) with
15 marks and the (b) aspect which covered a theory aspect on the problems of raising
capital by small firms. Even though the question paper allocated 5 marks to this (b) which
was an error this was rectified and the total 10 marks allocated for the total 25 marks
allocated to that question.

The (a) portion which was standard and quantitative posed challenges to the students in
calculating the various cost components and the overall weighted average cost of capital.
Only few students were able to answer it. This part contributed to the low pass rate in
this question. The marks allocated to the question relative to the time required and
complexity of the question appear small.

The (b) part was well attempted and students generally scored good marks in this area
contributing to the pass rate.

Page 14 of 25
QUESTION THREE

a) Return on investment is the average annual profit from an investment, after

depreciation, expressed as a percentage of the original capital invested. It is a useful
measure because it relates profit to capital employed. It is a measure used to compare
divisional performance. Since Wax Ltd has ten divisions the method would relate the
profitability of the various divisions to the level of investments in those divisions and
thereby provide a basis for comparing their level of performance.

i) Advantages of the use of the ROI (Return on Investment/return on capital

employed ROCE) lie in its tendency to:
 Focus management’s attention upon earning the best profit possible on the capital
(total assets) available.
 Serve as a yardstick in measuring management’s efficiency and effectiveness in
managing the company as a whole and its major divisions or departments.
 Tie together the many phases of financial planning, sales objectives, cost control, and
the profit goal.
 Afford comparison of managerial results both internally and externally.
 Develop a keener sense of responsibility and team effort in divisional and
departmental managers by enabling them to measure and evaluate their own
activities in the light of the results achieved by other managers.
 Aid in detecting weaknesses with respect to the use or non-use of individual assets
particularly in connection with inventories
(Any 4 points for 4 marks)

ii) Problems associated with ROI

 It is a profit measure and as such is only a worthwhile measure if it is high profit that
is the investor’s main objective.
 Profit could be defined in various ways as well as capital employed. It could be profit
before or after tax and various elements charged to profit may not have comparable
measures. Capital employed may or may not include debt capital.
 The fact that different divisions engage in different types of activities and some lines
of business generally yield higher returns than others may distort the basis of
comparison.
 ROI emphasizes profitability and may therefore lead to oversimplification of
investment decision making. Other factors that should be considered include capital
availability, liquidity, risks, etc.
 Possible suboptimisation by pursuing divisional goals to the detriment of corporate
objectives.
(Any 3 points for 3 marks)

Safeguards
 Other measures should be used in addition to ROI. Qualitative factors should also
be considered. This would deemphasize profit objective.

Page 15 of 25
  Investment decisions should be centralized as much as possible.
(2 points for 3 marks)

(Total: 25 marks)

b) As projects 2 and 8 are mutually exclusive, only the most profitable need be
considered, i.e. project 8. Project 2 can be completely omitted from the selection
process.
(2 marks)
As projects 1 and 5 are mutually dependent both must be either selected or rejected,
and to ensure this a weighted profitability index is needed.
(2 marks)
Outlay x Profitability index
1. 200,000 1.20 240,000
2. 200,000 1.15 230,000
400,000 470,000
470
Weighted profitability index = 400

= 1.175
(3 marks)
The projects can then be ranked in descending order of profitability:
Project Profitability index Outlay
9 1.22 100,000
8 1.21 100,000
7 1.19 400,000
1+5 1.175 400,000
1,000,000
3 1.17 100,000
10 1.16 100,000
6 1.13 200,000
4 1.10 300,000

Thus, projects 9,8,7,1 and 5 are accepted

(8 marks)

(Total: 25 marks)

EXAMINER’S COMMENTS
Question 3 again was a mixture of theory and quantitative questions. The (a) aspect
covered advantages and safeguards on the use of Return on Investment (ROI). This
question appeared unexpected to the students and attracted wide range of answers and
general thinking. Performance was generally above average and compelled students to
think outside the box.

Page 16 of 25
The (b) aspect which covered capital rationing for projects using profitability index and
also introducing mutually exclusive and mutually dependent projects in the list appeared
straight forward but students still did not understand it that way as majority of students
computed NPVs and ranking using that. Students wasted valuable time to do that. This
impacted negatively on the marks obtained in this area by students. Those who got it
right scored the maximum marks. Overall performance was above average

Page 17 of 25
QUESTION FOUR

a) Overtrading refers to a situation where turnover is increased without a matching

increase in equity or other long-term sources of funds: as a result, a company which
is earning good profits can run into a liquidity crisis and default in payment of its
current liabilities. (1 mark)

Symptoms of Overtrading
The financial backers of the tenanted-pub firms might have noticed the following
symptoms;
 The increased investment in current assets needed to support the increased sales are
financed mainly form short-term sources like creditors and bank overdraft, resulting
in a declining current ratio and quick ratio.
 Sales tend to increase very quickly in relation to equity, resulting in sharp increases
in the ratio of sales to equity.
 The increase in debt would lead to higher gearing ratios
 The net working capital will tend to decline, and may even become negative. A
negative net working capital implies a current ratio less than equity (current assets
less than current liabilities), and a business in such a position is likely to face
considerable difficulty in meeting its current liabilities. Even where the current ratio
is satisfactory, any erosion of net working capital would worsen the liquidity of the
business and make it more vulnerable to cyclical risk.
(Any 3 points for 3 marks)
Various possible causes
However over trading is not the only cause of these symptoms: Situations similar to
overtrading can be caused due to other reasons as well:

 It is not only physical increase in sales that can strain liquidity. In periods of high
inflation, sales turnover and the corresponding working capital requirements can
increase very sharply in nominal terms, resulting in the symptoms of overtrading.
 Repayment of a loan without raising sufficient long-term funds (either in the form of
profit accruals or a fresh loan) can drain cash form the firm, creating symptoms.
 Excessive dividend payout can result in depressing the equity and creating similar
symptoms.
 Using short-term sources of funds to finance long-term investments will depress net
working capital, resulting in overtrading symptoms.
(Any 2 points for 2 marks)

Overcoming overtrading
 However if the management of the tenanted-pub firms feel that overtrading is the root
cause of their condition then they must as a matter of urgency tackle the situation.
 The instant solution for an overtrading situation is to take more trade credit and bank
overdraft finance; however this is likely to be only a short-term fix that ultimately
exacerbates the situation and worsens the liquidity crisis.

Page 18 of 25
 Better short-term solutions would be to either restrict the growth in turnover to
manageable proportions; or improve working capital management so that the
investment in current assets required to support the level of sales is reduced (i.e. better
inventory control, credit policy and debt collection).
 The long-term solution is to provide more long-term funds for working capital
purposes – i.e. improve the Net Working Capital positon of the firm.
(Any 2 points for 2 marks)

b)
i) Economic Order Quantity of dints
2𝑐𝑑
Q = 𝑖𝑃

(d = 150,000 x 12 = 1,800,000)

2 𝑥 1,800,000 𝑥 200
Q = √ 8

Q = √90,000,000 = 9,487 units

(3 marks)
ii) Total inventory costs
𝐶𝑄 𝑆𝑂
TC = + 𝑄
2

(8)(9487) (1,800,000)(200)
TC = +
2 (9487)

Total costs = 37,948 + 37,947

= GH¢75,895
(2 marks)

iii) Many times per year Inventory should be ordered

(1,800,000)
= 190 times or approximately every 2 days
9,487

(2 marks)

(Total: 15 marks)

EXAMINER’S COMMENTS
This question also had (a) and (b) aspects. The (a) portion was standard and straight
forward on overtrading, symptoms, causes and how to overcome that. This was generally
understood and well answered.
The (b) portion which covered economic order quantity and the total inventory cost was
well answered and maximum marks obtained by students who understood the question.
Some students however deviated in calculating the annual demand using the finished

Page 19 of 25
product instead of converting back to the raw material on which economic order quantity
was based. Valuable marks were lost due to this deviation.
Students who read and understood the question did extremely well.

Page 20 of 25
QUESTION FIVE

a)
i) Net asset (liquidation) basis:
PV of bond:
As interest is paid semiannually:
The total number of periods over which the cash flows will be paid is 10 (2 X 5 years
remaining).
The required rate of return on assets of this risk level is 12% / 2 = 6% semiannually.

The formula for the present value of a non-callable redeemable bond is:
= PV of the coupon payments + the PV of the redemption value of the debt
PV = GH¢250,000 x (8.11) + GH¢5,000,000 x (0.675)
(From PV annuity tables, n = 10, r = 4% and PV tables n = 5, r = 8% and)
= GH¢2,027,500+ GH¢3,375,000 = GH¢, 402,500

Change in the value of fixed assets:

If we assume that both buyer and seller would accept the revaluation of assets by the
independent valuer, an assets valuation of equity would be as follows;

Adjusted Net Assets of LHW Ltd

GH¢ million GH¢ million

Balance sheet Figure 2.6
Estimated values of fixed assets
Land & Buildings 2.0
Plant & Machinery 4.0
Fixtures and Fitting 1.2
Motor Vehicles 0.35
9.0
Less fixed assets in balance sheet (1.45)
Current Assets:
Nominal value of debtors in balance sheet 2.5
20% reduction of value of debtors (0.5)
Nominal value of 8% of debentures in balance (5.0)
sheet
Redemption cost (5.4)
(0.4)
Adjusted net Assets of LHW Ltd 0.25
(3 marks)

Page 21 of 25
ALTERNATIVE SOLUTION

Adjusted Net Assets of LHW Ltd GH¢ million

Fixed Assets;
Land and buildings 2.0
Plant and Machinery 4.0
Fixtures and Fittings 1.2
Motor Vehicles 0.35
7.55

Current Assets:
Stock 1.1
Debtors 2.0
Cash 0.2
Prepayments 0.1
3.4
Current Liabilities:
Creditors 2.4
Taxation 1.5
Bank overdraft 0.1
4.0 (0.6)
6.95
Debenture (5.4)
Deferred Taxation (1.3) (6.7)
Adjusted Net Assets of LHW LTD 0.25

ii) P/E Ratio: Choosing the appropriate earnings figure:

As a company with significant growth since its start up, it would not be correct to believe
that past earnings are an appropriate measure for valuation. Future earnings should be
used.

Usually if no other information about the future is available one would use the latest
earnings figure and forecast that next year equals this year, i.e. €250,000. We could
however take the average of forecast earnings based on the directors’ assessment of
growth prospects for the next three years:
Year 2009 2010 2011 Average
Profits GH¢262,500 GH¢275,625 GH¢316,969 GH¢285,031

Page 22 of 25
Choosing the appropriate ratio:
The only P/E ratio for an earnings basis valuation given is that of 14 times for the quoted
company. This should be reduced by about 40%, to about 8.4, to allow for unquoted
status. A share valuation on an expected earnings basis might be as follows:

P:E Ratio Earnings Valuation # of Shares Value per

share
8.4 GH¢250,000 GH¢2,100,000 10,000,000 GH¢0.210
8.4 GH¢285,031 GH¢2,394,263 10,000,000 GH¢0.239
(4 marks)

iii) Dividend yield with no growth

The gross dividend yield for shareholders in the quoted company was 10%, and it is
reasonable to suppose that investors in LHW Ltd. Would require at least this yield,
(perhaps increased to allow for unquoted status, e.g. 14%). Again, usually if no other
information about the future is available or one is unhappy with the forecasts given, one
would use the latest dividend figure and forecast that next year equals this year, i.e.
GH¢100,000.

A yield basis valuation would therefore be:

GH¢100,000 / 0.1= GH¢1,000,000 = GH¢0.10 per share.

Or GH¢100,000 / 0.14 = GH¢666,666.67 = GH¢0.067 per share, (to allow for unquoted
status).
(3 marks)

iv) Dividend yield with growth

If one wished to use the forecast earnings, then as earnings are expected to increase by
5% a year for the next three years, with no further information we can assume g = its
capital gains yield = 5%. The dividend yield for the quoted companies was only 10%. For
LHW, an unquoted company, this could be increased by about 40% to 14%.

Since the required return for LHW = its dividend yield + its capital gains yield

That is to say: r = (Div1 / P0) + g

Thus r = 14% + 5% = 19%

Therefore using Gordon’s dividend growth model:

P0= D0 (1+g) / (r –G)–g) = 100,000(1.05) / (0.19 –0.05) = GH¢105,000 / 0.14 = GH¢750,000

or
GH¢0.075 per share. (2 marks)

Page 23 of 25
Summary: Company Per Share
GH¢ GH¢
Net Asset Value 247,500 0.025
P:E (Low) 2,100,000 0.210
P:E (High) 2,394,263 0.239
Div Yield (No Growth) 666,666.67 0.067
Div Yield (With 750,000.00 0.075
Growth)

b)
Standard deviation
Standard deviation, or total risk, is the square root of the weighted average
deviation of the returns on the individual stocks in a portfolio from the mean
return, E.g. for a two asset portfolio, the Standard Deviation (=”the total risk of the
portfolio‖) = σp=√ {X12σ21 +X22σ22 +2X1X2P12}

The standard deviation or total risk can be broken down into two forms, namely:
unsystematic risk which is diversifiable and systematic risk which is
undiversifiable.
(1 mark)
Beta
Beta is the slope of a regression line, and it equals the covariance of the return on
a security with the return on the market divided by the variance of the market
return:
Betai = covim / σm2

Beta measures the sensitivity of a stock‘s return to the return on the market
portfolio. The market portfolio is a portfolio of all assets in the economy. In
practice a broad stock market index, such as the S&P Composite, is used to
represent the market. By definition the Beta of the market portfolio is one and that
of the risk free asset is zero. While beta does not directly measure risk, it is a crucial
risk indicator, reflecting the extent to which the returns on the single asset move
with the market. (1 mark)

Appropriate measure
For an investor with an undiversified portfolio, it is total risk or standard deviation
which is the most appropriate measure of risk.

Unlike standard deviation, Beta is not a measure of total risk but a measure of
relative risk, the risk of an asset relative to the market. Beta is also a measure of
market risk. Market risk accounts for most of the risk of a well-diversified
portfolio. (1 mark)
(Total: 15 marks)

Page 24 of 25
EXAMINER’S COMMENTS
This question which also had (a) and (b) was mainly quantitative. Out of the 15 marks
allocated to the question the quantitative aspect covered 12 marks and the theory 3 marks.
The12 marks allocated however appear small relative to the requirements and complexity
of the question. It
The (a) portion was on valuation on net assets value, P/E and dividend yield basis. This
was poorly answered and scored the worst performance. Students struggled to answer
the question. The (b) aspect was also another a theory question on standard deviation
and beta. Students struggled to understand and explain the two concepts.

CONCLUSION
Remedies for observed weaknesses
 More preparation time by students before writing the paper
 Minimum period should be allowed by ICA before a student sit for the exams
depending on the background of the student
 More questions and answer bank and guide lines should be provided by the Institute
and other accredited tuition centres
 ICA tuition and revision centres should incorporate exam comprehension and
answering techniques as part of their revision lectures and kits to better guide
students preparing to write the exams
 Explore the possibility of implementing web based or electronic based tuition and
revision centres for students leaving outside the Accra area
 Implementation of mock like exams by the accredited tuition centres to help prepare
the students to have the feel of the exams before the main exams and feedback given
at individual level on what went well and what didn’t go well in the mock or pre
exam test even if it is at an affordable fee for students
 Re-evaluation of the quality of the students and admission requirements for the
Institute.

Page 25 of 25
 NOVEMBER 2018 PROFESSIONAL EXAMINATION
FINANCIAL MANAGEMENT (PAPER 2.4)
QUESTIONS & MARKING SCHEME

QUESTION ONE

a) Choosing a corporate objective of a firm is extremely important and has a determinant

factor to the success or failure of a corporation in controlling the market.

Required:
Explain FOUR (4) objectives of not-for-profit organisations. (4 marks)

b) Financial markets are the markets where individuals and organisations lend funds to other
individuals and organisations.

Required:
Explain the following under financial markets
i) Over the counter market (OTC)
ii) Dealers market
iii) Auction market
(6 marks)

c) Identify and explain FOUR (4) essential roles performed by a Finance Manager in order
for a corporate body to achieve its objectives. (10 marks)

(Total: 20 marks)

QUESTION TWO

a) Islamic financing is an emerging model of financing in the global financial markets.

Required:
i) Explain the term Riba in Islamic Finance. (2 marks)
ii) Explain the THREE (3) perspectives from which Riba can be viewed as forbidden or
unacceptable in Islamic Finance (3 marks)

b) The Board of Directors of Continental Bank Ghana Ltd (CBGL) decided through a Board
resolution to raise additional capital through rights issue to meet the new capital
requirement by Bank of Ghana. CBGL plans to issue 1 new share for every 3 shares held
by existing shareholders at 10% discount to its existing market price. CBGL currently has
6 million shares in issue at a book value of 2 cedis per share. CBGL maintains a dividend
payout ratio of 50% and earnings per share currently is 1.6 cedis. Dividend growth is 5%
per annum and this is expected into the foreseeable future. CBGL’s cost of equity is 15%.
The issue cost is 600,000 cedis.

Required:
Calculate:
i) The market price per share (2 marks)

Page 1 of 17
ii) The capitalization of CBGL. (2 marks)
iii) The rights issue price (2 marks)
iv) The theoretical ex-right price (2 marks)
v) The market capitalization after the rights issue (2 marks)

c) KAF is a manufacturer of consumer electronics based in Accra, Ghana. KAF finances its
investments with a combination of equity and debt. Its equity capital comprises 10 million
shares which are currently trading on the stock exchange at GH¢2.55 per share. Its equity
beta is 2.1 currently. The return on the risk-free security is 12.5% while the equity risk
premium is 10%.

Included in KAF’s debt stock are irredeemable bonds that have a total face value of GH¢10
million while their total market value is GH¢12 million. The annual coupon of the
irredeemable bonds is 18% but is paid semiannually.

The directors of the company are considering two new investment opportunities, which are
described below:

Project 1
This is an expansion project in the consumer electronics manufacturing industry. It involves
the setting up of a new factory in the northern part of Ghana. KAF would finance it with
existing capital.

Project 2
This involves the installation of a new factory to manufacture furniture for export to foreign
markets. Although this investment is a completely new line of business, KAF plans to
finance it with existing capital. The average equity beta for the furniture manufacturing
industry is 1.52 and average industry capital structure is 60% equity and 40% debt.

It is expected that KAF’s tax rate will remain at 22%.

Required:
i) Compute the cost of capital that should be used as discount rate for appraising Project 1.
(5 marks)
ii) Compute the cost of capital that should be used as discount rate for appraising Project 2.
(5 marks)

(Total: 25 marks)

Page 2 of 17
QUESTION THREE

a) Sevista Ltd is evaluating the purchase of a new machine to produce product SEP, which
has a short product life-cycle due to rapidly changing technology. The machine is expected
to cost GH¢1 million. Production and sales of product SEP are forecasted to be as follows:

Year Production and sales (units/year)

1 35,000
2 53,000
3 75,000
4 36,000

The selling price of product SEP (in current price terms) will be GH¢20 per unit, while the
variable cost of the product (in current price terms) will be GH¢12 per unit. Selling price
inflation is expected to be 4% per year and variable cost inflation is expected to be 5% per
year. No increase in existing fixed costs is expected since Sevista Ltd has spare capacity in
both space and labour terms. Producing and selling product SEP will call for increased
investment in working capital.

Analysis of historical levels of working capital within Sevista Ltd indicates that at the start
of each year, investment in working capital for product SEP will need to be 7% of sales
revenue for that year. Sevista Ltd pays tax of 25% per year in the year in which the taxable
profit occurs. The new machine is expected to have no scrap value at the end of the four-
year period. Sevista Ltd uses a nominal (money terms) after-tax cost of capital of 12% for
investment appraisal purposes.

Required:
i) Determine the net present value of the proposed investment in product SEP. (13 marks)
ii) Advise whether the project should be undertaken. (2 marks)

b) Fluctuations in interest rate is a major concern to entrepreneurs and business executives. It

has been observed that interest rate on loans vary according to the term of the loan. Besides,
interest rates vary over time for varied reasons.

Required:
i) Explain THREE (3) reasons why interest rates on loans may differ for different maturities
as explained by the term structure of interest rate. (6 marks)
ii) Suggest FOUR (4) ways of hedging the company’s exposure to interest rate risk. (4 marks)

(Total: 25 marks)

Page 3 of 17
QUESTION FOUR

Kankam Ghana Ltd currently operates a long working capital cash cycle. Management is
considering an initiative to reduce the cash cycle in order to manage the size and cost of
the company’s working capital. Below are the components of working capital under the
existing policy.

Existing
GH¢
Cash 1,000,000
Debtors 4,000,000
Inventory 6,000,000
Creditors 4,000,000

Under the proposed policy or initiative,

 Cash is expected to increase by 50%
 Debtors is expected to reduce by 25%
 Creditors is expected to increase by 25%
 Current ratio is expected to be 1.9 times.

The cost of funds to the company is 20% per annum.

Required:
a) Calculate the company’s net working capital under existing and proposed policies.
(5 marks)
b) Compute the change in the company’s working capital financing cost if the new policy is
implemented. Advise management on whether to implement the new policy. (3 marks)

c) Explain the importance of the cash conversion cycle in ascertaining the working capital
needs of the company. (4 marks)

d) Explain THREE (3) advantages to be derived from effective management of Accounts

Receivable. (3 marks)

(Total: 15 marks)

Page 4 of 17
QUESTION FIVE

a) Flue Ltd wishes to make a takeover bid for the shares of Donc Ltd an unquoted company.
The earnings of Donc Ltd over the past five years have been as follows:
GH¢
2013 40,000
2014 57,600
2015 54,400
2016 56,800
2017 60,000

The average P/E ratio of quoted companies in the industry in which Donc Ltd operates is
10. Quoted companies which are similar in many respects to Donc Ltd are:
 Beans Ltd has a P/E ratio of 15, but is a company with very good growth prospects.
 Wash Ltd has had a poor profit record for several years and has a P/E ratio of 7.

Required:
Calculate a suitable range of valuations for the shares of Donc. Ltd (9 marks)

b) Food Ltd has in issue 12% bonds with par value GH¢150,000 and redemption value
GH¢165,000 with interest payable quarterly. The cost of debt on the bonds are 8% annually
and 2% quarterly. The bonds are redeemable on 30 June 2021 and it is now 31 December
2017.

Required:
Calculate the market value of the bonds. (6 marks)

(Total: 15 marks)

Page 5 of 17
SOLUTION TO QUESTIONS

QUESTION ONE

a) Objectives of not-for-profit organisations

 The welfare of employees
An organisation might try to provide good wages and salaries, comfortable and
safe working conditions, good training and career development, and good
pensions. If redundancies are necessary, many not for profit organisations will
provide generous redundancy payments, or spend money trying to find
alternative employment for redundant staff.

 Survival
One of the first economic objectives of a non-for-profit is to raise enough money to
meet its operating expenses in order to survive. These might include staffing
needs, rent, utilities, insurance, furniture, computers and the other normal
expenses of running a business. Some non-for-profits are staffed with employees,
while others use an association management company or a contract executive
director and vendors.

 Fundraising
A key economic goal of charities is to raise funds to meet their charitable purposes.
The process of fundraising goes beyond holding events or sending out mailings. A
complete development effort includes creating a database of regular donors,
applying for grants, seeking individual and corporate donations and holding
events such as balls, auctions, raffles and sporting events. The cost of fundraising
efforts can outweigh the total money spent on an organization’s charitable purpose
at new or smaller organizations.

 Compliance
The GRA sets target qualified distribution, or charitable spending, levels for some
tax-exempt organizations, and these organizations set objectives to meet their
requirements. For example, if an endowment earns GH¢100,000 annually for a
nonprofit and the nonprofit only donates GH¢10,000 of that money, the GRA
might fine the organization or ultimately revoke its tax-exempt status.

 Related and Unrelated Business Income

Some not-for-profit, especially trade associations that are not not-for-profit, seek
to raise money by charging for dues, selling newsletter advertising, sponsorships,
educational materials, logoed items, holding events, seminars or a conference or
holding a trade show. If the sales don’t relate directly to the organization’s
purpose, this is known as unrelated business income and is taxable. Unrelated
business income is often a major financial objective of organizations with low dues
and contributions. Dues are considered related business income. Advertising
revenue that covers the cost of an educational publication is related business
income, while profits from ads might be considered unrelated and taxable income.

Page 6 of 17
 Endowment
Not all of the money a charity raises goes toward administration or service. Many
not-for-profit have an economic objective of creating an endowment, which is a
financial account that generates enough interest each year to fund charitable
activities. Some not-for-profit set an objective of a dollar amount for their
endowment, such as creating a GH¢1 million endowment. Once the fund is fully
endowed, the organization sets an annual spending objective for the interest
earned.

 Welfare of the society

Social objective are those objectives of business, which are desired to be achieved
for the benefit of the society. Since business operates in a society by utilizing its
scarce resources, the society expects something in return for its welfare. No activity
of the business should be aimed at giving any kind of trouble to the society.

If business activities lead to socially harmful effects, there is bound to be public

reaction against the business sooner or later. Social objectives of business include
production and supply of quality goods and services, adoption of fair trade
practices and contribution to the general welfare of society and provision of
welfare amenities.
(Any 4 points well explained for 4 marks)

b)
i) Over the counter market (OTC)
A decentralized market, without a central physical location, where market
participants trade with one another through various communication modes such
as the telephone, email, and proprietary electronic trading systems. An over-the-
counter (OTC) market and an exchange market are the two basic ways of
organizing financial markets. In an OTC market, dealers act as market-makers by
quoting prices at which they will buy and sell a security, currency, or other
financial products. A trade can be executed between two participants in an OTC
market without others being aware of the price at which the transaction was
completed. In general, OTC markets are typically less transparent than exchanges
and are also subject to fewer regulations.
(2 marks)
ii) Dealers market
A dealer market is a financial market mechanism wherein multiple dealers post
prices at which they will buy or sell a specific security of instrument. In a dealer
market, a dealer – who is designated as a “market maker” – provides liquidity and
transparency by electronically displaying the prices at which it is willing to make
a market in a security, indicating both the price at which it will buy the security
(the “bid” price) and the price at which it will sell the security (the “offer” price).
Bonds and foreign exchange trade primarily in dealer markets.

Page 7 of 17
 (2 marks)

iii) Auction market

In an auction market, buyers enter competitive bids and sellers enter competitive
offers at the same time. The price at which a stock is traded represents the highest
price that a buyer is willing to pay and the lowest price that a seller is willing to
accept. Matching bids and offers are then paired together, and the orders are
executed. The New York Stock Exchange (NYSE) is an example of an auction
market.
(2 marks)
c) The roles played by the financial managers are:
 Raising of Funds
In order to meet the obligation of the business it is important to have enough cash
and liquidity. A firm can raise funds by the way of equity and debt. It is the
responsibility of a financial manager to decide the ratio between debt and equity.
It is important to maintain a good balance between equity and debt.

 Allocation of Funds
Once the funds are raised through different channels the next important function
is to allocate the funds. The funds should be allocated in such a manner that they
are optimally used. In order to allocate funds in the best possible manner the
following point must be considered
 The size of the firm and its growth capability
 Status of assets whether they are long-term or short-term
 Mode by which the funds are raised
These financial decisions directly and indirectly influence other managerial
activities. Hence formation of a good asset mix and proper allocation of funds is
one of the most important activity

 Profit Planning
Profit earning is one of the prime functions of any business organization. Profit
earning is important for survival and sustenance of any organization. Profit
planning refers to proper usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the
economy, mechanism of demand and supply, cost and output. A healthy mix of
variable and fixed factors of production can lead to an increase in the profitability
of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and
machinery. In order to maintain a tandem it is important to continuously value the
depreciation cost of fixed cost of production. An opportunity cost must be
calculated in order to replace those factors of production which has gone through
wear and tear. If this is not noted then these fixed cost can cause huge fluctuations
in profit.

Page 8 of 17
 Understanding Capital Markets
Shares of a company are traded on stock exchange and there is a continuous sale
and purchase of securities. Hence a clear understanding of capital market is an
important function of a financial manager. When securities are traded on stock
market there involves a huge amount of risk involved. Therefore a financial
manger understands and calculates the risk involved in this trading of shares and
debentures.

It’s on the discretion of a financial manager as to how to distribute the profits.

Many investors do not like the firm to distribute the profits amongst shareholders
as dividend instead invest in the business itself to enhance growth. The practices
of a financial manager directly impact the operation in capital market.

 Cash management (Working Capital Management)

Cash Management is an important aspect of your business because it provides you
with a process of monitoring, analyzing and adjusting the cash flow of your
business which will enhance liquidity and profits while also reducing risk.

 Risk Management
The role of a Finance Manager is to communicate risk policies and processes for an
organisation. They provide hands-on development of risk models involving
market, credit and operational risk, assure controls are operating effectively, and
provide research and analytical support.
(4 points well explained @ 2.5 marks = 10 marks)

(Total: 20 marks)

QUESTION TWO

a)
i) Riba in Islamic Finance refers to any predetermined interest charged by the lender
to a borrower which the lender receives above the capital amount granted by the
lender whether the borrower makes money or not the interest is paid at the
predetermined level. This is absolutely forbidden in Islam. (2 marks)

ii) There are three perspectives from which Riba can be viewed as
Unacceptable or forbidden.
 Borrowers perspective
With the borrower, it becomes unfair when the borrower struggles to raise the
requisite revenue and finance to pay for the interest when the profit generated is

Page 9 of 17
 less than the predetermined interest cost. This can stress the cash flow and finance
of the borrower but pass on undue benefit to the lender, which is considered unfair
in Islamic law.

 Lenders perspective
The unfairness nature of Riba to the lender emanates from the lower real value of
what the lender receives during an inflationary period or environment. This will
often generate returns, which is less than or below inflation making the lender lose
on real return basis but to the benefit of the borrower.

 From the economy’s perspective

This can generate or lead to inefficient allocation of resources in the economy and
contribute to instability. Capital will flow to the most credit worthy customers,
which might be the areas rather than the areas that will make the most use of
resources or capital.
(3 points well explained for 3 marks)

b)
i) Market price per share
Dividend per share (DPS) = 50% X 1.6 = 0.8

D0 = 0.8 , g= 5% and r= 15%

Price = D0 (1+g) 0.8 (1.05) 0.84

------------ = --------------- = ------------ = 8.4 cedis
r- g 0.15-0.05 0.10
(2 marks)
ii) Market capitalization = price per share x issued shares
= 8.4 x 6m shares
= 50.4m cedis
(2 marks)
iii) Rights issue price @ 10% discount of the current market price = 90% x 8.4 =
7.56 cedis
(2 marks)
iv) The theoretical ex-right price
= 3 shares @ 8.4 = 25.2
1 share @ 7.56 = 7.56
--------- -------
4 shares 32.76
------------ -----------
= 32.76 / 4 = 8.19 per share
(2 marks)

Page 10 of 17
v) Market capitalization at the right issue:

Cash raised or cash proceeds from the issue = 6 million shares / 3 = 2 million shares
= 2 million shares x 7.56 = 15.12 million cedis
Value before the right issue = 6 million shares x 8.4 = 50.4 million
Cash raised from right issue = 15.12 million
-------------------
65.52 million
Less issue cost 0.6 million
---------------------
64.92 million
----------------------
(2 marks)
c) KAF Electronics Ltd (KAF)
i) The project 1 falls within KAF’s existing line of business, and so would not present
different level of business risk. Besides, it would not affect the company’s financial
risk as it would be financed with existing capital. Therefore, the appropriate
discount rate for appraising this project is the company’s existing WACC, which
is 26.52%:
Ve Vd
WACC = × ke + × k dt
Total value Total value
GH¢25.5m GH¢12m
WACC = × 33.5% + × 11.7% = 26.52%
GH¢37.5m GH¢37.5m

Ve = 10m x GH¢2.55 = GH¢25.5m

Vd = GH¢12m
Total value = GH¢25.5m + GH¢12m = GH¢37.5m

Cost of equity:
ke = rf + β(rm − rf)

ke = 12.5% + 2.1(10%) = 33.5%

After-tax cost of debt:

Interest on debt = 18% x GH¢10 m = GH¢1.8m

Interest(1 − t)
k dt =
Market value ex int

GH¢1.8m (1 − 0.22)
k dt = = 0.117
GH¢12m

(Marks allocation: ke = 1.5 marks; kdt = 1.5 marks; WACC = 2 marks)

(5 marks)

ii) As the Project 2 would be financed with existing capital, it would not affect the
company’s financial risk. However, it may present different business risk as it is a

Page 11 of 17
different line of business. Therefore, the company’s existing WACC would not be
an appropriate discount rate for appraising it. A new project-specific cost of capital
that reflects the risk associated with the project should be used.

The cost of equity would be affected by the different business risk inherent in the
furniture manufacturing business. The new cost of equity is computed as under:

First, ungear the average equity beta in the Furniture Manufacturing Industry
using the average industry capital structure to obtain the asset beta for that
industry:
Ve
βa = × Be
Ve + Vd (1 − t)
60
βa = × 1.52 = 1.00
60 + 40(1 − 0.22)
Second, re-gear the asset beta from the Furniture Manufacturing Industry to obtain
an equity beta that reflects the financial risk of the company:
Ve + Vd (1 − t)
βe = × βa
Ve
25.5 + 12(1 − 0.22)
βe = × 1.00 = 1.367
25.5
Third, put geared (equity) beta into the CAPM to obtain the appropriate cost of
equity:
ke = rf + β(rm − rf)

ke = 12.5% + 1.367(10%) = 26.17%

The risk-adjusted WACC is computed as under:

GH¢25.5m GH¢12m
WACC = × 26.17% + × 11.7% = 21.5%
GH¢37.5m GH¢37.5m

(Marks allocation: asset beta = 1.5 marks; new equity beta = 1.5 marks; new ke
= 1 mark; risk-adjusted WACC = 1 mark)
(5 marks)

(Total: 25 marks)

Page 12 of 17
QUESTION THREE
a)
i) Calculation of Net Present Values
GH¢
Year 0 1 2 3 4
Sales revenue 728,000 1,146,390 1,687,500 842,400
Variable costs -441,000 -701,190 -1,041,750 -524,880
Contribution 287,000 445,200 645,750 317,520
Capital allowances -250,000 -250,000 -250,000 -250,000
Taxable profit 37,000 195,200 395,750 67,520
Tax @ 25% 9,250 48,800 98,938 16,880
After tax profit 27,750 146,400 296,813 50,640
Capital allowances 250,000 250,000 250,000 250,000
After tax cash flows 277,750 396,400 546,813 300,640
Initial Investment -1,000,000
Working capital -50,960 -29,287 -37,878 59,157 58,968
Net cash flows -1,050,960 248,463 358,522 605,970 359,608
Discount factor @ 12% 1 0.893 0.797 0.712 0.636
Present values - 1,050,960 221,842 285,812 431,317 228,537
NPV 116,548
Workings
Sales revenue
Year 1 2 3 4
Selling price (GH¢/unit) 20.8 21.63 22.50 23.40
Sales volume (units) 35,000 53,000 75,000 36,000
Sales revenue (GH¢) 728,000 1,146,390 1,687,500 842,400
Variable costs
Variable costs (GH¢/unit) 12.60 13.23 13.89 14.58
Sales volume (units) 35,000 53,000 75,000 36,000
Variable costs (GH¢) 441,000 701,190 1,041,750 524,880
Working capital
Year 0 investment = 728,000 x 0.07 = 50,960
Year 1 investment = 1,146,390 x 0.07 = 80,247
Year 2 investment = 1,687,500 x 0.07 = 118,125
Year 3 investment = 842,400 x 0.07 = 58,968
Incremental investment in working capital
Year 0 investment = 728,000 x 0.07 = 50,960
Year 1 investment = 80,247 - 50,960 = 29,287
Year 2 investment = 118,125 - 80,247 = 37,878
Year 3 recovery = 58,968 - 118,125 = 59,175
Year 4 recovery = 58,968
(13 marks evenly spread using ticks)

Page 13 of 17
ii) The project is therefore profitable and must be implemented. (2 marks)

b)
i) Reasons why interest rates on loans may differ for different maturities as
explained by the term structure of interest rate include the following:
 Liquidity preference theory: There seems to be a mismatch between the loan
terms that lenders are ready to provide and the loan terms that borrowers demand.
In general, lenders prefer giving short-term loans whereas borrowers prefer long-
term loans. The liquidity preference theory explains that since lenders prefer short-
term loans to long-term loans, they will offer short-term loans at lower rate but
long-term loans at higher rates.

 Expectations theory: The yield curve depends on expected future inflation.

Normally, average expected rate of inflation increases over time. Therefore, loans
with longer terms are expected to provide higher inflation premium, which
implies a higher interest rate, whilst loans with shorter terms may provide lower
inflation premium, which implies a lower interest rate.

 The market segmentation theory: The market for funds can be segmented into
two: the market for short-term funds and the market for long-term funds.
According to the market segmentation theory, the yield curve could be upward
sloping, flat, or downward sloping depending on the supply and demand
conditions in each market. For instance, if during a period, there are fewer lenders
willing to offer long-term loans but more borrowers demanding long-term loans,
there will be shortage of funds in the market for long-term funds and excess fund
in the market for short-term funds. Consequently, rates on long-term loans will be
higher than rates on short-term loans, and the yield curve will be upward sloping.

 Government policy: Actions of the central bank in relation to management of

interest rate may affect the yield on debt stocks of different maturities.
(Marks allocation: 2 marks for each of 3 reasons = 6 marks)

ii) Ways of hedging the company’s exposure to interest rate risk include the
following:
 Matching: The company would much assets and liabilities with common interest
rates. That is, if an investment will yield constant payoffs then it should be financed
with a loan with fixed interest rate and vice versa.
 Smoothing: The company would keep a balance between its fixed rate borrowing
and floating rate borrowing.
 Forward rate agreement: The company would hedge its exposure to interest rate
risk by fixing the interest rate on future short-term borrowing. This is done
through an over-the-counter arrangement with a bank.
 Interest rate futures: The company would speculate on the movement of interest
rate by buying/selling standardized contracts to lend/borrow at a futures rate.

Page 14 of 17
 Interest rate option: The company would buy an option to obtain the right to
borrow at a predetermined strike interest rate. This would allow the company to
limit adverse interest rate movements while taking advantage of favourable
interest movements.
 Interest rate swap: The company would agree to exchange interest rate payments
with a counter party.
(Marks allocation: 1 mark for each of 4 strategies = 4 marks)

(Total: 25 marks)

QUESTION FOUR

a)
Before After
GH¢ GH¢
Cash 1,000,000 1,500,000
Debtors 4,000,000 3,000,000
Inventory 6,000,000 5,000,000
11,000,000 9,500,000
Less creditors 4,000,000 5,000,000
Net working capital 7,000,000 4,500,000
(5 marks)

Cost of capital @ 20% Before After

1,400,000 900,000
b) Savings = 1,400,000- 900,0000
=GH¢500,000
Management should therefore change the existing policy as that will give the
company savings of GH¢500,000
(3 marks)

c) Importance of the cash conversion cycle in ascertaining the working capital

needs of the company
 A Cash conversion cycle is the sum of stock or inventory days and trade debtors
or receivables days less the trade creditors or payables days.eg. if stocks days
is 60 days and debtor days is 30 and creditor days is 40 days then the cash cycles
days will be = 60+30-40 = 50 days.
 Investment in working capital requires financing which comes at a great cost
to the business. The longer the cash cycle the bigger the financing requirement
and hence the cost and vice versa.

Page 15 of 17
  Any management strategy that will reduce the cash cycle to the barest
minimum will reduce the working capital locked up and its associated cost.
This will have a positive impact on the profits and vice versa.
(Any 2 points @ 2 marks each =4 marks)
d) Advantages to be derived from effective management of Accounts
Receivable. Good receivables management is a comprehensive process
which helps the company in:
 Determining the customer’s credit rating in advance
 Frequently scanning and monitoring customers for credit risks
 Maintaining customer relations
 Detecting late payments in due time
 Detecting complaints in due time
 Reducing the total balance outstanding (DSO)
 Preventing any bad debt in receivables outstanding
(Any 3 points for 3 marks)
(Total: 15 marks)

QUESTION FIVE

a)
 Earnings
Average earnings over the last five years have been GH¢ 53,760 and over the last
four years 57,200. There might appear to be some growth prospects, but estimates
of future earnings are uncertain.

A low estimate of earnings in 2018 would be perhaps GH¢ 57,200. A high estimate
of earnings might be GH¢60,000 or more.
(4.5 marks)
 P/E ratio
A P/E ratio of 15 (Beans) would be much too high for Donc Ltd, because the
growth of Donc Ltd earnings is not as certain, and Donc. Ltd is an unquoted
company.
On the other hand, Donc Ltd’s expectations of earnings are probably better than
those of Wash Ltd. A suitable P/E ratio might be based on the industry’s average,
10; but since Donc Ltd is appropriate: perhaps 60% to 70% of 10= 6 or 7, or
conceivably even as low as 50% of 10=5.

The valuation of Donc Ltd shares might therefore range between:

High P/E ratio and high earnings: 7 X GH¢ 75,000= GH¢ 525,000; and
Low P/E ratio and low earnings: 5 X GH¢ 71,500 = GH¢ 357,500.
(4.5 marks)

Page 16 of 17
b) You need to use the cost of debt as the discount rate, and remember to use an
annuity factor for the interest. We are discounting over 14 periods (quarters) using
the quarterly discount rate (8%/4)
Period Cash flow Discount Present
factor value
GH¢ 2% GH¢

1-14 Interest 4,500 12.11 54,495

((0.12*150,000)/4))
14 Redemption 165,000 0.758 125,070

179,565

Market value is GH¢179,565

(6 marks)

(Total: 15 marks)

Page 17 of 17
 NOVEMBER 2019 PROFESSIONAL EXAMINATIONS
FINANCIAL MANAGEMENT (PAPER 2.4)
CHIEF EXAMINER’S REPORT, QUESTIONS AND MARKING SCHEME

STANDARD OF THE PAPER

The standard and quality of paper was generally good and in line with expectation
Additionally, the questions were distributed fairly across the syllabus and mix
between quantitative and theory questions was 64% and 36% respectively a shift
towards quantitative compared to prior sitting of 53% to 43% respectively. The
theory questions were generally straight forward that produced good answers
from candidates. The style of questions was easy to understand and apply by
students who prepared well and had knowledge of the subject.

No sub-standard questions were noted in the paper and the quality of questions
considered appropriate for that level. Mark allocations were also considered to be
satisfactory and fair. In terms of marking scheme, it was reviewed and aligned to
the question paper. Alternative solutions were also provided where necessary to
accommodate various approaches to answering the questions.

PERFORMANCE OF CANDIDATES
The performance of the students showed a remarkable improvement in this sitting
compared to the prior sitting. The pass rate was about 23% compared to the
previous sitting of 7% driven by combination of good questions and better
preparation by students.
The possible reasons for some poor performance were as follows:
 Inadequate preparation by some students.
 Poor questions answering skills.
 Poor, labelling of questions, handwriting and use of faded pens making reading
and marking difficult.
 Poor knowledge in answering questions that required thorough knowledge and
understanding of the subject.

NOTABLE STRENGTHS & WEAKNESSES OF CANDIDATES

The about 23% of the students who passed the paper and those who did well in
some questions exhibited the following strengths:
 Improvement in the understanding of the requirements of the questions.
 Better appreciation and preparation in the theory areas of the syllabus.
 Improvement in understanding and application of what was studied.
 Better understanding of the requirements of quantitative aspect of the questions.
 Growth in knowledge and understanding of how to handle applied questions in
the exams.

Observed reasons of the strengths:

 Enhancement in the quality of tuition
 Access to quality study materials through the use of technology
 Better preparation this time due to the poor performance for last sitting.

Page 1 of 21
 The strengths can be enhanced by:
 Review of the study materials relevant to the new syllabus
 Improving on digital channels of study
 Knowledge and experience sharing by good performing past students

Observed weaknesses demonstrated by students

 Still poor understanding of finance principles by some students
 Weak knowledge and poor handling of the non-quantitative aspect by some
students
 Continuous poor numbering of answers to questions making it difficult for
examiners
 Deterioration in arrangement of answers to questions with answers to some
questions scattered across different pages haphazardly
 Still poor handwriting and faded pens making reading and marking difficult for
examiners

Remedies for observed weaknesses

 Performance feedback sessions by the Institute or through the various tuition
centres
 Use and practice more on exercises and past questions,
 Review of the evaluation process for student’s enrolment

Page 2 of 21
QUESTION ONE

a) The financial sector is one of the most highly regulated sectors of any country. Notably,
each industry under the financial sector has a special regulatory framework consisting of
statutes to shape the conduct of participants in the industry and a regulator to foresee
compliance and promote fairness and efficiency.

Required:
i) Describe THREE (3) functions the Securities and Exchange Commission of Ghana (SEC)
is expected to perform towards achieving fairness and efficiency in the securities industry.
(6 marks)
ii) Explain TWO (2) implications of the regulatory functions of the SEC for corporate
investing and financing activities. (4 marks)

b) A colleague has been taken ill. Your managing director has asked you to take over from
the colleague and to provide urgently-needed estimates of the discount rate to be used in
appraising a large new capital investment. You have been given your colleague’s working
notes, which you believe to be numerically accurate.

Working notes: Estimates for the next five years (annual averages)
Stock market total return on equity 16%
Own company dividend yield 7%
Own company share price rise 14%
Standard deviation of total stock market return on equity 10%
Systematic risk of own company return on equity 14%
Growth rate of own company earnings 12%
Growth rate of own company dividends 11%
Growth rate of own company sales 13%
Treasury bill yield 12%

The company’s gearing level (by market values) is 1 : 2 debt to equity, and after-tax
earnings available to ordinary shareholders in the most recent year were GH¢54,000,000,
of which GH¢21,400,000 was distributed as ordinary dividends.

The company has 1 million issued ordinary shares which are currently trading on the Stock
Exchange at GH¢3.21. Corporate debt may be assumed to be risk-free. The company pays
tax at 30% and personal taxation may be ignored.

Required:
Estimate the company’s weighted average cost of capital using:
i) The dividend valuation model;
ii) The capital asset pricing model.
State clearly any assumptions that you make.
Under what circumstances these models would be expected to produce similar values for
the weighted average cost of capital? (10 marks)

(Total: 20 marks)

Page 3 of 21
QUESTION TWO

Global companies continuously explore ways to be more efficient and effective to survive
the challenging global competition. Some resort to mergers and acquisitions to survive. In
the light of this, Carsley Ltd and Powell Ltd are planning to merge to form Stimac Ltd. It
has been agreed that Powell’s shareholders will accept three shares in Carsley for every
share in Powell they hold. Other details are as follows:

Carsley Ltd Powell Ltd

Number of shares 40m 10m
Annual earnings GH¢10m GH¢5.8m
P/E ratio 8 10

Post-merger annual earnings of the enlarged company are expected to be eight per cent
higher than the sum of the earnings of each of the companies before the merger, due to
economies of scale and other benefits. The market is expected to apply a P/E ratio of 9 to
Stimac Plc.

Required:
a) Explain to the stakeholders of both companies the justification on for the following
integration strategies in mergers and acquisitions.
i) Horizontal take-over. (4 marks)
ii) Vertical backward and forward take-overs. (4 marks)
iii) Conglomerate mergers. (2 marks)

b) Determine the extent to which the shareholders of Powell will benefit from the proposed
merger. (10 marks)

(Total: 20 marks)

QUESTION THREE

a) Joy Mummy Ltd is establishing an endowment fund to finance a scholarship scheme to

provide funding for the education of children of its employees. The company plans to make
an initial deposit of GH¢500,000 into the fund now. The initial deposit will be invested for
three years before any disbursements will be made from the fund. The effective annual rate
of return on the fund is expected to be 14% in the first year, 15% in the second year, and
16.5% in the third year.

Required:
Compute the balance of the fund at the end of three years. (4 marks)

b) Wobete Ltd is offering 5 million units of 15-year bonds with a face value of GH¢100 each.
Though the bonds are being offered at a price of GH¢95 each, the bonds will be redeemed
at a premium of 10%. The annual coupon rate of the bonds is 15%. Interest is payable at
the end of every six months.

Page 4 of 21
 A provision in the bond indenture requires that Wobete Ltd establishes a sinking fund to
accumulate enough money to pay the total redemption value of the bonds upon maturity.
To comply with this provision, Wobete Ltd plans to set aside an even amount at the end of
each quarter over the next 15 years. Each of the even amounts that will be set aside will be
invested at an annual interest rate of 12% with quarterly compounding.

Required:
Calculate the even amount that should be put into the sinking fund at the end of each quarter
to raise enough money to pay the total redemption value of the bonds. (6 marks)

c) Explain TWO (2) differences between forward contracts and futures contracts.
(5 marks)

d) ValuePack Ghana Ltd is into the manufacturing and sale of drugs in Ghana. The company
imports its raw materials from abroad on credit. The suppliers grant them between 3 months
and 6 months credit due to their good track record in payment. The company currently has
the following invoices due in:

3 months’ time - USD 2 million

6 months’ time - USD 1 million

They are looking to buy USD/GH¢ forward to hedge their exchange rate risk and their Bank
offers them the following forward rates:
Tenor Rates
3 months - 5.65
6 months - 5.98

The interest rates applicable to their company for both cedi and US dollar for the same
tenors are as follows:
Tenor GH¢ Interest Rate USD interest rate
3 months 15% 2%
6 months 20% 3%

The Spot rate for USD/GH¢ is 5.4 in the market.

Required:
As the newly appointed Finance and Treasury Director of the company, calculate the
forward rates for the various tenors based on the information provided above. (5 marks)

(Total: 20 marks)

Page 5 of 21
QUESTION FOUR

The current financial year of General Kapito Ltd, a sports apparel company based in Ghana,
will be ending in two months’ time. The directors of the company will be meeting next
week to approve capital projects that will be implemented in the coming financial year. A
major concern for the coming year is the availability of finance to meet investment
requirements.

The cost of raising new capital in Ghana’s capital market has risen so high that it is not
cost-effective to raise small blocks of capital. Consequently, the directors of the company
have decided to finance new projects in the coming year with retained earnings and not
raise new external capital from the capital market to bridge any financing gap. The
maximum amount of retained earnings that will be available for financing new capital
projects in the coming year is GH¢62 million.

There are six independent projects that will be presented before the board of directors for
approval in their upcoming meeting. Five of the projects have been appraised already (see
a summary of the projects in the table below).
Project Investment Net present value Internal rate of return
requirement (NPV) (IRR)
PROJECT-01 25 50 36.2%
PROJECT-02 15 45 37.1%
PROJECT-03 9 35 39.5%
PROJECT-04 12 20 34.8%
PROJECT-05 34 To be computed To be computed
PROJECT-06 5 2 33.5%

Project-05 refers to a 5-year contract with a local football club for the manufacture and
supply of a special football boot for playing under rainy conditions. It is estimated that this
project will require an investment of GH¢34 million in plant and equipment at the start of
the first year. The estimated cost of required plant and equipment might change as there are
speculations about probable change in technology in the coming year. That
notwithstanding, this project is expected to return an after-tax net operating cash flow of
GH¢13.5 million every year over the coming five years. The estimated after-tax salvage
value of the plant and equipment is GH¢10 million at the end of the fifth year.

The company’s required rate of return is 25%.

Required:
a) Compute the NPV and IRR of Project-05. (10 marks)

b) Assess the sensitivity of the outcome of Project-05 to variations in the cost of plant and
equipment. Interpret your result. (5 marks)

c) Assuming the projects are divisible, recommend the portfolio of projects that should be
funded in the coming year. (5 marks)

(Total: 20 marks)

Page 6 of 21
QUESTION FIVE

a) In driving the profitability and liquidity position of an organisation in the current local and
global business environment, one area that has become the centre of focus or attention to
Management is how working capital is managed. Aggressive, moderate and conservative
policies to working capital management have implications on the profitability and liquidity
positions of the organisation.

Required:
In the light of the above explain and demonstrate the impact of each of the policies below
on profitability and liquidity:
i) Aggressive Working Capital Management; (2 marks)
ii) Moderate Working Capital; (2 marks)
iii) Conservative Working Capital Management; (2 marks)

b) Taaba Oil Ghana Ltd is an Oil Marketing Company operating in the downstream
Sector of the Oil and Gas industry in Ghana. The company initially was offering 4 weeks
credit to its retailers until it changed it strategy to reduce the credit period from 4 weeks to
2 weeks to manage down it financing cost and bad debt.

Under the 4 weeks credit regime, annual credit sales was 500 million liters. The profit made
per litre before financing charge and bad debt was GH¢0.20 (Twenty pesewas). The total
working capital was GH¢250m but 50% was funded through trade credit and the remaining
50% was through Bank Overdraft at an interest rate 25% per annum. The cost of trade credit
was already factored in the margin. Bad debt was at GH¢ 0.01 (one pesewa per litre) of the
credit sales.

The change in policy from 4 weeks to 2 weeks was done immediately without prior advance
discussion and notice period granted to retailers who were also selling on credit to their
customers.

After operating the new credit policy, the volume of sales was negatively impacted as sales
volume per annum dropped by 25% and bad debts increased by 100% due to pressure on
the working capital of the retailers.As the new Finance Manager for Taaba Oil Ghana Ltd,
you are tasked to review this policy.

Required:
i) Calculate the profit under the old policy. (4 marks)
ii) Calculate the profit under the new policy. (4 marks)
iii) Based on your calculations above, advise management whether to revert to the old policy
or maintain the new policy. (1 mark)

c) Holding stock and sometimes over-stocking come at a great cost to a company. Not
withstanding these costs, it is sometimes necessary to hold stock or even over stock for the
smooth running of the company

Required:
i) Explain TWO (2) reasons for holding stock. (2 marks)
ii) State and explain THREE (3) costs associated with holding stocks. (3 marks)
(Total: 20 marks)

Page 7 of 21
SOLUTION TO QUESTIONS
QUESTION ONE
a)
i) Functions of the SEC of Ghana
The SEC of Ghana is expected to perform the following functions:
 to advise the Minister responsible for Finance on all matter relating to the securities
industry
 to maintain surveillance over activities in securities to ensure orderly, fair and
equitable dealings in securities;
 to register, licence, authorise or regulate stock exchanges, investment advisers, unit
trust schemes, mutual funds, securities dealers, and their agents and to control and
supervise their activities with a view to maintaining proper standards of conduct
and acceptable practices in the securities business;
 to formulate principles for the guidance of the industry;
 to monitor the solvency of licence holders and take measures to protect the interest
of customers where the solvency of any such licence holder is in doubt;
 to protect the integrity of the securities market against any abuses arising from the
practice of insider trading;
 to adopt measures to minimize and supervise any conflict of interests that may
arise for dealers;
 to review, approve and regulate takeovers, mergers, acquisitions and all forms of
business combinations;
 to examine and approve of the new issue of securities on the stock exchange (i.e.,
IPO);
 to create the necessary atmosphere for the orderly growth and development of the
capital market;
[3 functions @ 2 marks each = 6 marks]

ii) Implications of the regulatory functions of SEC for corporate financing

decisions
The regulatory functions of the SEC have the following implications for corporate
financing:
 When making securities offers, companies must ensure that the offer is fair and
equitable. For instance, all potential buyers must be treated equally, and
communications relating to the offer should be true and fair.
 The company, its members, and directors cannot trade securities based on insider
information.
 The company cannot engage in any form of business combination without the
approval of the SEC.
 The company will need approval from the SEC when making an IPO.
[Marks allocation: 2 implications @ 2 marks each = 4 marks]

Page 8 of 21
b)
i) Dividend valuation model
If we assume a constant growth in dividends, we may estimate the cost of
equity by using:
D1 𝐺𝐻¢21,400,000 × 1.11
Ke = +g= + 0.11 = 7.51 𝑜𝑟 751%
MVEx div 𝐺𝐻¢3,210,000

Cost of debt (Kd), as corporate debt is assumed to be risk free, is 12%, the
Treasury bill yield.

The after-tax cost is 12(1 - 0.30) = 8.4%

The weighted average cost of capital (WACC) is found as follows:

MVE MVD
WACC = (K E × ) + (K D × )
MVTOTAL MVTOTAL
2 1
WACC = (751% × ) + (8.4% × ) = 503.45%
3 3
(5 marks)
ii) Capital asset pricing model
Cost of equity may be estimated using:

R E = R RF + (R M − R RF )
The beta value of the security may be found using:
S 14%
= = = 1.4
M 10%
RE = 12% + 1.4(16% - 12%) = 17.6%

Kd = 7.8% as in part (i)

2 1
WACC = (17.6% × ) + (8.4% × ) = 14.53%
3 3
If the stock market is in equilibrium, and the inputs into the models are correctly
specified (e.g., the dividend valuation model reflects only systematic risk), then the
cost of equity Ke from the dividend valuation model should approximately equal the
expected return on equity E(re) of the CAPM.
(5 marks)
(Total: 20 marks)

Page 9 of 21
 EXAMINER’S COMMENTS
 This question consisted of (a) and (b) parts with two sub questions (i) and (ii) under
each.
 The (a) (i) part covered the functions of the Securities and Exchange Commission
(SEC) for 6 marks and (a) (ii) covered the implications of regulatory functions for
corporate investing and financing activities for 4 marks
 The (b) part centred on the calculation of weighted Average Cost of Capital
(WACC) using dividend valuation model and capital assets pricing for a total of
10 marks.
 On the average about 25% of the candidates got pass mark in this question. The (a)
part was theory and was the part best answered with candidates struggling to
compute the cost of equity, and beta value of the security in the (b) part of the
question. Additionally, the cost of equity based on the question appeared
unusually high and coming from the market value of equity. Either the share price
in the question or the number of shares was not aligned.
 Students were marked based on how the question appeared on the question paper
and the solution based on that.
 Overall it was a marginally answered and the third worst answered question

Page 10 of 21
QUESTION TWO

a)
i) Horizontal take-over
 Economies of scale
The major justification put forward to explain horizontal mergers centre on the fact
that the merging companies are in the same industry and so are likely to benefit
from economies of scale. They may also benefit from synergy between operations
as well.
 Breaking entry barriers
Horizontal mergers can also be justified as a way of breaking into new
geographical markets.
 Obtaining Monopoly Power
Market share can also be a viable reason, so that companies can earn monopoly
profits, but the bidder must beware of referral to the MMC.
 Enhanced Shareholder value
There may be financial economies and tax benefits from mergers, but increasing
EPS is not a valid justification.
(2 points well explained @ 2 marks each = for 4 marks)

ii) Vertical backward and forward take-overs

 Control of Raw Materials
Here the major justification is that a company can either secure control of vital raw
material or guarantee an outlet for, and control the distribution of its product.

 Control of Distribution Channels

This helps companies to reduce the power of suppliers or to decrease the revenue
lost to distributors. Economies of scale or synergy are less likely to occur than with
horizontal take-overs.
(2 points well explained @ 2 marks each = 4 marks)

iii) It is very difficult to see the rationale for conglomerate take-overs, as there will be
few economies of scale or synergy due to the unrelated nature of the merging
businesses. The take-over cannot be justified from the point of view of risk
reduction, as shareholders are likely to hold diversified portfolios. Nor can the
take-over be justified as the acquisition of a bargain, since if capital markets are
efficient; the target’s share price will reflect its true value.
(2 marks)

b)
 Powell’s market value, using its P/E ratio and earnings, is 5.8m x 10 = ¢58m
(2 marks)
 The earnings of Stimac Ltd will be (¢10m + ¢5.8m) x 1.08 =¢17.06m (2 marks)
 Using a P/E ratio of 9, the value of Stimac is ¢17.06m x 9 = ¢153.54m (2 marks)

Page 11 of 21
 The 10m shares of Powell will be swapped for 30m Carsley shares, making 70m
shares in the new company in total. Therefore the wealth of Powell’s shareholders
will now be ¢153.54m x (30m/70m) = ¢65.8m. (2 marks)
 Powell’s shareholders are ¢7.8m better off (78 cedis per share). (2 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
 Question 2 was a merger question with (a) part being theory on vertical take over,
horizontal forward and backward take overs and conglomerate mergers. This part
had a total of 10 marks. The pass rate was average
 The (b) part which was to determine the extent to which the shareholders of Powell
who were to take new shares were to benefit from the proposed merger became
difficult for students to determine. Most students scored low or poor marks here
which carried a total of 10 marks and half the total marks for question 2.
 Overall performance in this question was generally poor with less 14% of the
students passing in this question

Page 12 of 21
QUESTION THREE

a) Endowment fund
𝐹𝑉3 = 𝑃0 (1 + 𝑖1 )(1 + 𝑖2 )(1 + 𝑖3 )

𝐹𝑉3 = 𝐺𝐻¢500,000 × (1.14 × 1.15 × 1.165)

𝐹𝑉3 = 𝐺𝐻¢500,000 × 1.527315 = 𝐺𝐻¢763,657.5

(Interest factor = 1; Computation of future value = 2; final answer = 1)

(4 marks)
b) Sinking fund
As the objective of the sinking fund is to raise enough money to pay the
redemption value of the bonds when they mature in 15 years’ time, the future
value of the sinking fund (SF) should be equal to the total redemption value of the
bonds (Total RV):

𝑆𝐹15 = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑉15

𝑇𝑜𝑡𝑎𝑙 𝑅𝑉15 = 𝑈𝑛𝑖𝑡𝑠 × (𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 × 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 𝐹𝑎𝑐𝑡𝑜𝑟)

𝑇𝑜𝑡𝑎𝑙 𝑅𝑉15 = 5,000,000 × (𝐺𝐻¢100 × 1.10) = 5,000,000 × 𝐺𝐻¢110

= 𝐺𝐻¢550,000,000

𝑖 𝑛
(1 + 𝑚) − 1 𝑖
𝑆𝐹𝑛 = 𝑃𝑀𝑇 [ ] (1 + )
𝑖 𝑚
𝑚

The future value of the sinking fund, SFn = GH¢550,000,000

Annual interest, i = 12%

Frequency, m = 4

Term (in years), t = 15

Number of periods, n = Term x Frequency = 15 x 4 = 60

0.12 60
(1 + 4 ) − 1
550,000,000 = 𝑃𝑀𝑇 [ ]
0.12
4

Page 13 of 21
 550,000,000 550,000,000
𝑃𝑀𝑇 = 60 = = 3,373,127.31
0.12 163.0534368
(1 + 4 ) −1
[ 0.12 ]
4

That is, Wobete Ltd will have to deposit GH¢3,373,127.31 into the sinking fund at
the end of each quarter.

[Total redemption value = 2 marks; Interest factor = 1; Computation of

instalment = 2; Final answer = 1]
(6 marks)
c) Differences between Forwards and Futures Contract
 Forward contract are non-standardized but Futures contracts are standardized as
to delivery date, quality and quantity
 Forward contracts are over the counter contracts but Futures contracts are traded
on an organized exchange
 Forwards contract have no clearing houses but Futures contracts have clearing
houses
 No margin requirement under Forward but margin requirement exist under
Futures contract
 Credit risk is higher in Forward contracts but minimal on Futures contracts due to
the margin requirements.
(Any 2 points @ 2.5 marks each =5 marks)
d)
i) 3 months Forward:
Forward rate= spot rate x (1+ R GH¢ x days/day basis)
(1+ R USD x days/day basis)

Forward rate= 5.4 x (1+ 15% x 3 months/12 months)

(1+ 2% x 3 months/12 months)

Forward rate= 5.4 x (1.0375)

(1.005)

= 5.4 x 1.0323
= 5.574
(2.5 marks)

6 Months forward:
Forward rate= spot rate x (1+ R GH¢ x days/day basis)
(1+ R usd x days/day basis)

Forward rate= 5.4 x (1+ 20% x 6 months/12 months)

(1+ 3% x 6 months/12 months)

Page 14 of 21
 Forward rate= 5.4 x (1.1)
(1.015)

= 5.8522
(2.5 marks)

ALTERNATIVE (Assuming the interest rates were understood to be for the specific
tenor and not per annum as question was silent)

ii) 3 months Forward:

Forward rate= spot rate x (1+ R GH¢ x days/day basis)
(1+ R USD x days/day basis)

Forward rate= 5.4 x (1+ 15%)

(1+ 2%)

Forward rate= 5.4 x (1.15)

(1.02)

= 5.4 x 1.1274
= 6.088

(2.5 marks)

6 Months forward:
Forward rate= spot rate x (1+ R GH¢ x days/day basis)
(1+ R usd x days/day basis)

Forward rate= 5.4 x (1+ 20%)

(1+ 3%)

Forward rate= 5.4 x (1.2)

(1.03)

= 5.4 x 1.1650
=6.29

(2.5 marks)

(Total: 20 marks)

Page 15 of 21
 EXAMINER’S COMMENTS
 This question had a total of 20 marks covering (a) to (d)
 The (a) part was on an endowment fund with students expected to calculate the
balance on the fund with an initial deposit to be invested for first three years at
given interest rates for each of the 3 years carrying 4 marks. Those who understood
the question got the maximum marks for determining the balance at the end of the
3 years. Some students deviated and scored very poor marks
 The (b) part was on bond issue and the establishment of sinking fund to
accumulate enough funds for the redemption of the bond on maturity. Candidates
were required to determine the even amount that should be put aside on quarterly
basis to achieve this. This was poorly answered except few students who got it
right and scored the maximum marks. This carried 6 marks
 The (c ) part was on basic difference between a forward and futures contract. This
part which contained 5 marks was generally well answered and attracted
maximum marks
 The (d) aspect which was the calculation of basic forward for 3 months and 6
months tenors got some students struggling to calculate this. Some did well and
scored the maximum marks. Those who assumed the interest rates quoted were
for the specific tenors and not annual were also considered since the question was
silent on that.
 On overall basis this was the worst answered question with less than 10% passing
driven mainly by the poor performance in (a) and (b) parts of the question and to
some extent the (d). The (d) had an overload of information not needed for the
specific aspect the students were required to answer.

Page 16 of 21
QUESTION FOUR

(a) Appraisal of Project-05

NPV of Project-05
Period NCF DF @ 25% PV @ 25% DF @ 35% PV @ 35%
EOY 0 -34 1.0000 (34.00) 1.0000 (34.00)
EOY 1-5 13.5 2.6893 36.31 2.2200 29.97
EOY 5 10 0.3277 3.28 0.2230 2.23
NPV 5.58 (1.80)

IRR of Project-05
NPVL
IRR = iL + [( ) × (iH − iL )]
NPVL − NPVH
5.58
IRR = 25% + [( ) × (35% − 25%)] = 32.56%
5.58 + 1.80

Project-05 should be okayed for the next stage of the appraisal process as its NPV is
positive and IRR is greater than the required rate of return.
[Marks allocation: NPV computation = 6 marks; IRR computation = 4 marks]

(b) Sensitivity of NPV of Project-05 to cost of plant and equipment

𝑁𝑃𝑉
𝑆𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 % = × 100%
𝑃𝑉 𝑜𝑓 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑙𝑎𝑛𝑡 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡

28.54
𝑆𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 % = × 100% = 83.9%
34

The cost of the plant and equipment will have to increase by 83.9% for the NPV of the
project to become zero. This implies that the project will no longer be viable if the cost
of equipment and plant increases by more than 83.9%.
[Marks allocation: Computation of sensitivity percentage = 4 marks; Interpretation
= 1 mark]
ALTERNATIVE

𝑁𝑃𝑉
𝑆𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 % = × 100%
𝑃𝑉 𝑜𝑓 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑙𝑎𝑛𝑡 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡

Page 17 of 21
 5.58
𝑆𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 % = × 100% = 16.41%
34
[Marks allocation: Computation of sensitivity percentage = 4 marks;
Interpretation=1 mark]

(c) Recommended portfolio of projects that should be funded in the coming year
Computing the profitability index (PI) of the various projects and ranking them

Project PI = NPV/Investment Rank

PROJECT-01 2.0 3
PROJECT-02 3.0 2
PROJECT-03 3.9 1
PROJECT-04 1.7 4
PROJECT-05 0.2 6
PROJECT-06 0.4 5

Allocating available funds to the projects based on PI ranking

Investment
Rank Project required Allocation NPV
1 PROJECT-03 9.0 9.0 35.0
2 PROJECT-02 15.0 15.0 45.0
3 PROJECT-01 25.0 25.0 50.0
4 PROJECT-04 12.0 12.0 20.0
5 PROJECT-06 5.0 1.0 0.4
6 PROJECT-05 34.0 0.0 0.0
Total 100.0 62.0 150.4

The recommended portfolio:

The company should fund projects 3, 2, 1, and 4 in full and fund 1/5 of project 6 for
a combined NPV of GH¢150.4 million.

[Marks allocation: Profitability index and ranking = 3 marks; Recommended

portfolio = 2 marks]

(Total: 20 marks)

Page 18 of 21
 EXAMINER’S COMMENTS
 Question four was on project appraisal. The (a) part required the computation of
Net Present Value (NPV) and Internal Rate of Returns (IRR) for the project which
carried 10 marks. This part received good answers from students and most
students scored the maximum marks. Students generally were able to correctly
compute the NPV and IRR.
 The (b) aspect which covered on sensitivities of the project to variations in the
cost of plant and equipment also attracted some good answers with those
students who understood scoring the maximum marks. This carried 5 marks.
 The final part of the question (c ) was on project ranking and capital rationing.
This part was also generally well understood and well answered.
 This question on overall basis was one of the best answered questions. It was the
second best answered question with average 37% pass rate. The question
however was loaded with a lot of information but that notwithstanding it got the
best responses from students.

Page 19 of 21
QUESTION FIVE

a)
i) Aggressive working capital refers to company using lower levels of cash, stocks
and debtors relative to the high level of business activity. The working capital
assets are over stretched to cover the high and growing volume of activity.
This sweats the assets better to create more profits but at the expense tight liquidity
that might expose the company to liquidity risk. (2 marks)

ii) Moderate working policy is the middle ground between aggressive and
conservative. It provides levels of working capital needed in line with the levels of
business activity. It impacts moderates profits and also moderates the liquidity
risk. (2 marks)

iii) Conservative working capital policy is where too much working assets are held
relative to the low volume of business activity and could counter to profit
generation but provides more than sufficient liquidity levels. (2 marks)

b)
(i) Old Credit Policy (4 weeks of credit)
Credit sales volume (Liters) 500,000,000
Commission or margin per liter (0.2 cedis) x 0.2 cedis
GH¢
Total profit before interest and Bad debts 100,000,000
Financing cost (50% x 250m x 25%) (31,250,000)
Bad Debts (0.01 cedis x 500m) (5,000,000)
Profit after Financing and Bad debts 63,750,000
(4 marks)

(ii) New Credit Policy (2 weeks of credit)

Credit sales volume (Liters) (75% of 500m) 375,000,000
Commission or margin per liter (0.2 cedis) x 0.2 cedis

GH¢
Total profit before interest and Bad debts 75,000,000
Financing cost (75%x 250m =187.5m x50% x25%) (23,437,500)
Bad Debts (0.02 cedis x 375m) (7,500,000)
Profit after Financing and Bad debts 44,062,500
(4 marks)
(iii) Profit made under Old policy 63,750,000
Profit under new policy (44,062,500)
Difference 19,687,500

Decision
Based on the analysis the new policy implemented resulted in profit reduction of
GH¢19.68m and the new policy should therefore be reversed immediately.
(1 mark)

Page 20 of 21
c)
i) Reasons for holding stock
 To cater for unexpected spike or increase in demand.
 To maintain existing and loyal customers as stock outs could drive away
customers.
 For seasonality purposes for goods that experience spike in demand on seasonal
basis.
 To manage the cost of ordering and take advantage of discounts on bulk orders.
 Avoid the cost of emergency orders due to stock outs.
 To ensure smooth flow of production process without any hitches.
 Information that market prices are likely to move up and therefore stocking to take
advantage of the price increases when they occur to make profit and also preserve
working capital.
 Information that there would be shortage of supply in the market.
(Any 2 points at 1 mark=2 marks)

ii) Cost of Holding stock

 The cost of storage of warehousing.
 Risk of expired and damaged goods.
 Fraud and pilfering risk.
 Stores administration cost.
 The cost of insurance.
 Opportunity cost of locked funds in stock.
(Any 3 points at 1 = 3 marks)

(Total: 20 marks)

EXAMINER’S COMMENTS
 The final question 5 was a combination of theory and quantitative covering (a) to
(c).
 The ( a) part was theory on aggressive, moderate and conservative working capital
strategies and their implications on liquidity and profitability. This carried a total
of 6 marks and averagely received good answers from students.
 The (b) aspect which carried 9 marks was on review of credit policy in the oil and
gas industry which required students to calculate profits under an old policy, new
policy and advise as to whether to revert to the old credit policy or maintain the
new policy based on the results. The (b) (i) part which carried 4 marks was well
answered followed by the (b) (ii) which also carried 4 marks and (b) (iii) carrying
1 mark
 The final aspect of the question was (c ) was on the reasons for holding stock and
the cost associated with holding stock. This was well answered by majority of
students and carried 5 marks totalling 20 marks for the question.
 This was the best answered question with an average of 50% pass rate.

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